Capitalizing on
asset volatility
Mean reversion trading is a strategy where investors bet that the price of securities will revert to the mean value or mean reversion point following a significant decrease in its value. Mean reversion traders are not concerned with whether prices are high or low, just if the prices are mean-reverting. These strategies have been shown to exist in multiple markets and time horizons.
If a company's stock price is currently $8 and the mean price is $12, mean reversion traders would buy stocks at their lowered price, anticipating that they will return to the average for a profit on the investment.
Using mean
reversion trading.
Mean reversion trading works best on mean reverting assets with a high transaction volume, such as currencies or commodities. Traders buy an asset after a substantial rise or fall in price from its median. Keep in mind though that a dramatic price movement may also signify a change in public perception, creating a new mean.
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How investors benefit.
Mean reversion is based in math, as opposed to visual patterns, which makes it easier to program as an automated strategy. But traders use mean reversion trading strategies every day without even realizing it. This works best in a trending or volatile markets where prices move up and down quickly. Mean reversion may happen every day, but it requires the ability to pick the tops and bottoms of a price chart.