Adrian Reid explains mean reversion: prices bounce above and below a trend line, then snap back to it. He uses a 20-day moving average on the S&P 500 to show how this pattern works, and argues that trading systems built on it can hit high win rates with steady returns.
20-day exponential moving average (EMA).
S&P 500.
Hey, Adrian, here in this video, I want to introduce you to the concept of mean reversion trading strategies. But first, before we get into that, what is mean reversion and why do we talk about mean reversion as a trading strategy? But before we go any further, make sure you hit the subscribe button and give this video a thumbs up so that you get notified of all of my future videos. Because I've got new trading content coming out all the time and I don't want you to miss a thing. Well, mean reversion is the tendency for something to move or oscillate around some sort of average or mean and revert back to that mean. And so if you look at a stock chart, what you'll see often is there's a trend that happens, a primary trend either up or down, or it could be sideways and around that trend the price oscillates or fluctuates. And the mean reversion, if you like, is the tendency for it to move below that trend and then bounce back to the average or move above that trend and bounce and spring back down to the average. Let's bring this to life by looking at the chart. This is just a chart of the S&P 500. If you look at this, I've just got a simple, sorry, 20 day exponential moving average drawn on this chart in red here. Then you can see the red down days, the green up days, and if you look at the price, the price tends to move above the average and then snap back in an uptrend and it bounces back and then in a downtrend it moves down and then tends to snap back and then moves down again and tends to snap back. This is what we talk about as mean reversion. Now the cool thing about this is if you create a system around this concept of mean reversion, you can get a really high win rate in your system and generate quite smooth returns. Because reversion to the mean is a very reliable concept. It happens constantly because stock prices are always oscillating around the primary trend. If you can capture that, you can generate a really great trading strategy. If you want to learn more about mean reversion trading and how it all works, watch the next video in this series or keep reading if you're watching this on the blog post and I'll see you in the next section. Bye for now.
Sam.
