Mean Reversion Strategy
Mean reversion capitalizes on the statistical tendency of prices to return to their average after extreme moves. When a stock drops significantly below its moving average or hits oversold RSI levels, the strategy enters expecting a snap-back rally.
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How It Works
- 1
Identify stocks trading 2+ standard deviations below their 20-day moving average
- 2
Confirm oversold conditions with RSI below 30 and Bollinger Band touch/breach
- 3
Wait for a reversal candle (hammer, bullish engulfing) as entry trigger
- 4
Set stop below the recent low with a 1.5:1 reward target at the moving average
- 5
Exit at the moving average or on failure to bounce within 2-3 days
Best For
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Frequently Asked Questions
What is mean reversion in trading?
Mean reversion is the theory that stock prices tend to return to their historical average over time. When a stock moves far from its average (measured by moving averages, standard deviations, or RSI), the strategy bets on a return to normal levels.
When does mean reversion work best?
Mean reversion works best in range-bound, non-trending markets where stocks oscillate around a central value. It tends to underperform in strong trending markets where momentum carries prices further from the mean.
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