Mean Reversion

Mean reversion is based on the assumption that price will always return (revert) to a mean (Moving Average), here’s what it means and how to trade it…

Mean Reversion

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Price reverts to the mean (Moving average), cuts through it, and RISES above it.  Price then once again, reverts to the mean (Moving average), cuts through it, and FALLS below it.

Applies To…

  • All time frames
  • All Moving Averages
  • All Currency pairs and most other instruments *

* Stocks – If a company goes bust and the value of that stock reduces to 0 mean reversion cannot and will not occur

The higher the time frame the longer it will take price to extend from and revert back to the mean (Moving Average).

The longer (in value) the Moving Average (mean) the more price will be able to extend away from the mean and thus, the longer it will take for price to revert back to the mean.

Personal Story

Once a subject that fascinated me mainly because of this quote “Mean reversion is as close as we get to a known certainty in the world of Forex trading”.

I spent many months on this, back-testing and more back-testing, Currency pair after Currency pair and time frame after time frame looking for a strategy to exploit this “known certainty”.  I made the following observations:

  • The higher time frames were best (4 Hour and above)
  • A larger mean (Moving Average) was best
  • Waiting for a larger move (percentage wise was best)

However, the issue with any strategy, I found, was determining an appropriate Stop.  This was compounded by the fact that although the mean (by default) is the obvious Target, by the time price reverted, much of the time the mean had risen to (or above) my Entry.  The other issue was that many times reversion takes much longer than expected, more often than than expected.

Perhaps this “known certainty” can be exploited, my choice, based on the above observations it is unlikely it will be me doing the exploiting.

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Mean reversion applies to ALL Moving averages on ALL time frames for ALL Currency pairs and most other instruments, see above for exceptions.

As close as we get to a known certainty in the world of Forex trading

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