Mean Reversion Trading
Why we trade mean reversion trading strategies?
There are multiple ways to trade or invest in the markets. These ways or methods could be divided into following broad categories:
Momentum / Relative Strength.
Buy & Hold.
Day Trading/ Scalping.
Mean Reversion / Swing Trading / Pullback Trading.
We at AccuTrade, belong in the mean reversion camp.
What is Mean Reversion??
It means strong & liquid stocks which experience a price pull back will “bounce” or revert towards their average price over the next several days. In simple terms it can also be called as pullback trading or swing trading based on certain rules. The psychology behind mean reversion strategy is to exploit human behavior at price extremes. People tend to get fearful & panic when the stock goes down & become overconfident & greedy when prices are going up. The premise of the strategy is to buying the selling & selling the buying or buying weakness & selling strength.
Why Mean Reversion or Swing Trading strategies??
Although no effort is being made that mean reversion strategies are the best compared to any other strategies mentioned above, we like it for the following reasons:
1. There are basic behavioral patterns which keeps on occurring in the markets like mean reversion & price pullbacks. For example, stock rises, pauses and pulls back because of profit booking and multitude of other reasons, people start to the panic and dump the stock, smart money comes in and supports the price and stock rises for a couple of days. This same cycle keeps on occurring and hopefully will keep on occurring in the future. So there are short term inefficiencies in the markets which can be consistently exploited.
2. Beyond the benefits of flexibility and maneuverability, Swing Trading is advantageous because it allows you to trade the market regardless of whether it’s up, down, or even sideways.
3. Short term trades lasting 5-7 days. The less time you are in the markets, the more you are immune to price shocks. We like to enter the markets only when there is an apparent edge in entering the positions or else wait for better opportunities. As you will find in our test results that average bars a position is held is between 3 to 7 days.
4.High number of winners which helps us to apply the strategy consistently.
5.Low Drawdowns helps us to achieve smother equity growth over a period of time. As we will see the strategies have low drawdowns compared to trend following strategies.