Reversion to the Mean

S

secxces

Hi All,

I wanted to take some time to discuss mean reversion strategies. I have had alot of interest in the subject for some time now. I was just wondering if anyone would be kind enough to post some examples reversion to the mean.

I have spoken to some that do use this type of approach. Some use indicators, some do not. Just some examples would be interesting to see. I know we have alot of traders on the boards that do this, from what I have read on the p&l thread. It slips through sometimes..lol.


- secXces
 
Can you post some examples?

Im not asking for a strategy or something, I was just looking to see a typical chart, maybe how the most typical indicators would be used, etc.
 
If you are using an average as your mean, it can be as simple as price moving away from the average by a certain amount triggering an entry. You can visualize this by plotting trading bands, or bollinger bands on your chart. When the upper or lower band is breached you could fade the move on the premise that price will return to the average, or you could assume it will test the other side of the trading band. Lots of ways to set this up. That's the basic principle anyway.
 
Quote from patrick_newB:

If you are using an average as your mean, it can be as simple as price moving away from the average by a certain amount triggering an entry. You can visualize this by plotting trading bands, or bollinger bands on your chart. When the upper or lower band is breached you could fade the move on the premise that price will return to the average, or you could assume it will test the other side of the trading band. Lots of ways to set this up. That's the basic principle anyway.
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I see, very interesting. I read a little on it, but it seems to be a highly quiet strategy.

I appreciate your response greatly, but could you elaborate a little more. Again with some more in depth examples.

Im just trying to wrap my brain around the concept.

Much Appreciated.


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Anyone else have any insight?

- secXces
 
Another example is using linear regression channels. Identify a trend by drawing a LR line through the price bars. Set parallel channel lines to this LR line at, say, 1 and 2 standard deviations above and below.

One approach is to trade trend continuation by waiting for price to move counter-trend "too far" i.e. 1 or 2 SD away from the LR line. The assumption is that the larger trend will most likely continue.

Another approach is to counter-trend trade by waiting for price to go "too far" from the LR line *with* the trend. Say the trend is long, you'd wait for price to go 1 or 2 SD above the LR line and short when it begins to correct.
 
Here is a chart example:

In this case I'm using 1.5 and 3.0 SD for another purpose, but the point is the same.

<img src=http://www.elitetrader.com/vb/attachment.php?s=&postid=1205876>
 

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Quote from secxces:

Hi All,

I wanted to take some time to discuss mean reversion strategies. I have had alot of interest in the subject for some time now. I was just wondering if anyone would be kind enough to post some examples reversion to the mean.

I have spoken to some that do use this type of approach. Some use indicators, some do not. Just some examples would be interesting to see. I know we have alot of traders on the boards that do this, from what I have read on the p&l thread. It slips through sometimes..lol.


- secXces
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reversion to what ? Price , PE or any other key stats ? Many stocks reverting to "mean"/steady PEG ratio while price of stock changes a lot.
 
Usually when "reversion to the mean" is used it means returning to the average. For example you're looking at a trading strategy that has a historical win percentage of seventy percent. If you observe ten straight wins, then you can expect to lose in the coming setups.
 
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