Mean Reversion

Markets are inherently emotional and tend to overreact. Whether it’s panic selling that drives a price too low or FOMO buying that drives it too high, prices often deviate significantly from their "fair value" (the mean). Mean reversion assumes that this deviation is temporary and that the price will ultimately be pulled back toward the average, like an elastic band snapping back.

• The "Mean": Usually defined by a moving average (e.g., 20-day or 50-day) or a structural price level.
• The "Bands": Traders often use indicators like Bollinger Bands or Keltner Channels to visually measure standard deviations away from the mean.
• The Entry: You enter a trade when the price hits an extreme (e.g., touches the outer Bollinger Band) and shows signs of exhaustion (e.g., a "reversal candlestick" or divergence in RSI).
• The Target: Your profit target is the mean itself—the moving average.

Mean reversion is dangerous in a strong, runaway trend. If a stock is in a "parabolic" trend, it can stay overbought for months. Rule: Only apply mean reversion strategies in ranging or choppy markets. If the asset shows high directional momentum, do not try to fade it—you will likely be run over.