RiskPicksWhat is Mean Reversion?
Mean reversion is the concept that prices tend to return to their average (mean) over time. When a stock moves too far from its average: whether measured by moving averages, VWAP, or Bollinger Bands: it tends to snap back.
Mean reversion setups
- Rubber band snaps: stocks stretched far from their 20 EMA or VWAP tend to revert
- RSI extremes: RSI above 80 or below 20 often precedes a reversion
- Bollinger Band touches: price touching the outer band often reverts to the middle
Mean reversion vs. momentum
These are opposing strategies. Mean reversion traders fade (trade against) big moves. Momentum traders ride them. The key is knowing which regime the market is in.