MEAN REVERSION
Overview
Betting that extreme price moves will revert back toward the historical average. When markets move far and fast in one direction, mean reversion traders fade the move, expecting a snap-back. Best applied to range-bound markets and highly liquid futures.
Setup
- 1.Identify statistical extreme using Bollinger Bands, RSI extremes, or Z-score from mean.
- 2.Confirm COT report shows extreme speculator positioning (contrarian indicator).
- 3.Enter against the move with defined risk (stop above/below the extreme).
- 4.Target the moving average or VWAP as the reversion point.
- 5.Scale into the position in stages rather than all at once.
Max profit
Distance from extreme to the mean — typically 50-70% of the initial move.
Max loss
If the move continues and your stop is hit — markets can stay extreme longer than expected.
Breakeven
Entry price.
When to use
In range-bound, sideways markets. When extreme sentiment readings coincide with extreme technicals. Natural gas and grain markets can be particularly mean-reverting.
When to avoid
In strong fundamental trends where the 'mean' itself is shifting (e.g., oil during a supply shock). Never fade a trend without confirmation from multiple indicators.