Mean Reversion Strategy — The Art of Counter-Trend Trading

What Is Mean Reversion?

Mean reversion is a statistical concept suggesting that prices, after deviating from their average, tend to return to that average. In trading, this means over-extended assets may pull back, and oversold assets may bounce.

Theoretical Foundation

Markets may overreact in the short term due to emotions, news, or capital flows, but prices tend toward fair value over time. Mean reversion strategies exploit these short-term over-extensions.

Common Tools

RSI Overbought/Oversold

• RSI < 30: Oversold territory, potential bounce
• RSI > 70: Overbought territory, potential pullback
• Caution: In strong trends, RSI can stay overbought/oversold for extended periods

Bollinger Bands

• Price touches upper band: May revert to middle band
• Price touches lower band: May bounce toward middle band
• Post-squeeze breakouts are not suitable for mean reversion

Z-Score

Measures how many standard deviations price has deviated from the mean. Z-Score > 2 or < -2 indicates extreme deviation with higher reversion probability.

Entry Strategy

Confirm the market is ranging or trendless

Wait for indicators to reach extreme zones

Wait for reversal candlestick confirmation

Enter, targeting the mean (e.g., Bollinger middle band)

Critical Warning

Mean reversion is extremely dangerous in trending markets! If the trend is strong, price may not revert but continue diverging. Always:

• Use ADX to confirm the market is ranging
• Set strict stop losses — don't hold and hope
• Scale into positions rather than all at once
• Execute stop losses immediately when triggered