Buy the dip, sell the rip β profit from price returning to average.
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Overview
Mean reversion is based on the statistical observation that extreme price deviations from a long-run average tend to be temporary. Just as a stretched rubber band snaps back, overextended prices tend to return to their mean over time. This principle is especially reliable in markets that exhibit stationary or co-integrated behaviour.
The strategy involves identifying when price has moved significantly away from a measure of central tendency β such as a moving average, the VWAP, or a regression line β and taking a position anticipating the return. Common entry triggers include price crossing more than two standard deviations outside a Bollinger Band, an RSI reading above 70 or below 30, or a Z-score exceeding Β±2 on a rolling regression.
Risk management is critical in mean reversion: the strategy can suffer large losses if a trending market extends far beyond expected bounds. Position sizing must account for the possibility of further extension before reversal. Traders often scale into positions as price moves further from the mean (pyramiding into a contrarian trade) and use wide stops to avoid premature exit.
Mean reversion works best in range-bound equity markets, currency pairs with long-term equilibrium rates, and in pair trading where two co-integrated assets temporarily diverge.
Strategy Code
This is a TradingView Pine Script strategy example for this page concept. Paste it into the TradingView Pine Editor, add it to your chart, and run it in the Strategy Tester.
//@version=6
strategy("Mean Reversion Strategy", overlay=true)
len = input.int(20, "BB Length")
mult = input.float(2.0, "Std Dev")
basis = ta.sma(close, len)This is a thinkorswim ThinkScript strategy example for this page concept. Open thinkorswim, create a custom strategy, paste the script, and apply it to your chart.
input length = 20;
input numDev = 2.0;
def mid = Average(close, length);
def up = mid + numDev * StDev(close, length);
def dn = mid - numDev * StDev(close, length);Join thousands of traders who use auto-Trading to execute this strategy automatically, 24/7.
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