What Is Mean Reversion?
Mean reversion is the trading thesis that price tends to oscillate around an average — and that extreme deviations from that average are eventually corrected. The strategy buys when price is unusually low and sells when it's unusually high, relative to a chosen baseline.
Tools: Bollinger Bands, RSI extremes, distance from moving averages, statistical Z-scores. The classic setup: price moves 2+ standard deviations from its 20-period mean, RSI in extreme territory, and you fade the move expecting return to the middle.
Mean reversion works in ranging markets and on instruments with established statistical mean (e.g. spread trades, paired stocks). It fails catastrophically in trending markets — 'this thing is overbought' is exactly when strong trends keep running. Mean reversion requires regime detection: know when to trade it and when to step aside.
Related terms
- Bollinger Bands — Volatility bands plotted at standard deviations above and below a moving average.
- RSI (Relative Strength Index) — A momentum oscillator (0-100) measuring the speed and magnitude of recent price changes.
- Trend — The general direction of price movement over a period — uptrend, downtrend, or sideways.
- Strategy