Mean reversion
Mean reversion is the idea that a price that has moved far from its recent average tends to move back toward it. A mean reversion rule buys after drops or sells after rises.
How Mean reversion is calculated
A common measure is a z-score: (price - average of n bars) / standard deviation of n bars. A rule might buy when the z-score is below -2 or when RSI(2) is below 10, and exit when price returns to the average or after a set number of bars.
How it is read
The idea fits ranges and fits some short-horizon moves. It does not fit a market that is changing level, where a stretched price simply keeps going.
Common mistakes
- Averaging down with no exit. A price can stay stretched or become a new level.
- Counting the many small gains and not the rare large loss.
- Testing only on assets that recovered. The ones that did not recover are often missing from the data.
Test it yourself
Use RSI with a short length in an entry rule (for example RSI is below 10) and exit after a set number of bars or on a stop. The Lab charges trading costs on every trade, fills on the next day's open, and shows how many attempts you have made.
What Tickfloor tested
Tickfloor's research desk has backtested 678 strategies, net of modelled trading costs. After correcting for the 761 tests run, 0 passed. That does not prove no strategy works. These are historical diagnostics, not validation under Testing Standard v2: the backtest harness predates that standard and has not been re-run to meet it.
- Buy the Dip (claim test)
- RSI(2) Mean Reversion (claim test)
- Buying a crypto crash: does picking the right crash help? (claim tested)
- Pairs Trading (claim test)
Lessons that cover it
- Momentum and mean reversion: two opposite stories
- Buy after a drop: the control that became a candidate
Related concepts
General information only. It doesn't consider your objectives, finances or needs. Tickfloor holds no financial services licence and never places trades.