Mean Reversion Strategies

ropunzel · July 30, 2020, 7:51pm

Greetings folks, I hope you are all good.

I just to ask if anyone has ever traded a mean reversion or similar strategy. That is placing a trade when you think the price will correct or revert back to the recent moving average after an initial breakout.

I am very interested to know what your current setup for a trade is if you do; at what point do you decide to enter that trade, where do you set your stop loss and take profit and what indicators if any do you use for your trade decision.

Much appreciate your input.

tradeforex077 · July 31, 2020, 11:09pm

Haha, I’ve tried loads of them. Never stuck to them though. The problem is they are normally against trend and therefore are less reliable. I used the 100 ema or any slower moving MA. Then I would trade price back to it on any reversal setup eg head and shoulders, divergence, support resistance etc… so any reason to sell back to the MA. Stop loss at high and exit at MA. You get loads of break evens but the winners were good risk reward. I dont use it because I just didnt have the patience to wait for them, preferred day trading to get in and out.

I wouldnt recommend day trading it on a faster MA. Price usually just keeps moving up until you’ve been stopped out multiple times and then sometimes drops but not always. The worst would be price extends away from for eg 20ma and when you think its stalling it will pullback slightly and then keep going. It’s very frustrating and requires good discipline and emotional control.

ropunzel · August 1, 2020, 7:50pm

@ tradeforex077

Greetings thank you for the reply. I think I have found something that can be a starting point for a signal generator. It is a modified version of your setup and you would need to apply some of the filters you normally use to model and refine it to your needs.

It is a mean reversion trade for false breakouts.

it consists of:

change in 50 SMA H1: SMA50(0) - SMA50(1) (this measures the steepness of the change in the moving average t the end of the last bar): Current Change (CChng)

The Indicator Looks like this (Green line)

Z-value using above change compared to previous 1,000 changes in SMA50

Taking the last 1,000 changes in H1 SMA50, find the mean change and Standard Deviation (StDev) of the changes.

The Z value is: (CChng - Mean )/ StDev - This measures how many standard deviations the current change is from the average

The Indicator Looks like this:

PlusMinus Directness: ((Close[0] - Close[50]) / 50) / ATR(50)

The Indicator looks like this (Purple- Red line is moving average (12) of first indicator)

Bollinger Band at Sigma 2 (in the main chart, there is a bollinger band at sigma 2 in black)

The Entry for Buy is:

(PlusMinusDirectnes >= AveragePlusMinusDirectness && Zscore >= -1 && Zscor <= 0.5 && Close[0] <= LowerBollingerBand)

These are situations where the price has dropped (broken out) below the lower Bollinger Band at sigma 2, but the corresponding rate of change in the moving average is low and still within -1 sigma compared to its last 1,000 values.

The price is outside its circa 97% probable range (sigma 2) but there is not a corresponding change the direction of the trend.

Take Profit: Mid point between SMA50 and current price
Stop Loss: Double the distance above

Note: the main feature that affects the win rate is the sigma value of the Bollinger Band. The higher the sigma value the higher the win rate.

You can also apply your own filters to improve the results but this seems to be a good starting template.

Note: For sell trades, use the opposite logic to the Buy entry.

Sample backtest:

AUDUSD BUY H1 2009 - 2019