Mean reversion is an investment strategy that attempts to take advantage of the cyclical nature of markets. It seeks to capitalize on overpriced securities and buy them at a lower price, expecting that they will return to their long-term average or mean in the future.
Mean reversion strategies can be used with individual stocks, options, futures contracts, commodities, currencies, and other asset classes.
Popular mean reversion trading strategies:
- Momentum Reversal Strategy
- Contrarian Investing
- Pairs Trading
- Value Investing
Momentum Reversal Strategy
The Momentum Reversal Strategy involves buying a security after it has dropped significantly from its recent high price.
By implementing this strategy, investors hope that momentum will reverse itself and the security’s price will move back towards its long-term mean.
The most common mean reversion strategy is one in which reverts back to the daily 200 moving average.
In this episode Senior trader Matt shows how to combine multiple indicators to improve a popular mean reversion strategy, and runs a test over the past 10 years to see the portfolio results.
If you would like to learn more about creating automated trading strategies check out the Trading Talk series which has a new episode each week with different topics and concepts on popular automated trading strategies.
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