Mean Reversion: Trading Back to Average
Bets that prices will return to their average after extreme moves, buying dips and selling rallies.
What is Mean Reversion?
Mean reversion is based on the principle that prices tend to return to their average over time. When an asset moves too far above its average, it's considered overbought and likely to fall. When it moves too far below, it's oversold and likely to rise. This strategy capitalizes on these statistical tendencies by trading against extreme moves.
Key Characteristics
Counter-trend: Trade against extreme price moves. Statistical edge: Based on probability of price returning to mean. Indicators used: Moving averages, Bollinger Bands, RSI. Risk management critical: Trends can extend further than expected. Works best in ranges: Less effective in strong trends.
Identifying Mean Reversion Opportunities
Look for price that has moved significantly away from its moving average—typically 2 or more standard deviations. RSI readings above 70 or below 30 can also signal extreme conditions. Bollinger Band touches or breaches are popular mean reversion signals. The key is waiting for confirmation that the extreme move is exhausting before entering.
Risks and Considerations
The biggest danger of mean reversion trading is that 'the market can stay irrational longer than you can stay solvent.' Strong trends can push prices far beyond statistical norms. Always use stop-losses, and consider the broader market context before fading a move. Mean reversion works best in ranging, choppy markets—not trending ones.
Practice Risk-Free
Master these concepts with paper trading before risking real capital.
Start Paper TradingDisclaimer: This article is for educational purposes only and does not constitute financial advice. Trading involves significant risk of loss. Cryptocurrency investments are volatile and high-risk. Always do your own research before making any investment decisions.