The Mean Reversion Trader – What Forex Style Suits You?
Mean reversion trading is built around the idea that high and low prices are temporary and a price will tend to go back to its average over time.
So a mean reversion trader will establish an average they think the price will revert towards, and levels they will trade when the price deviates far enough. This is similar to what market makers do in establishing a mid and standing ready to buy below that price and sell above it.
Famous Mean Reversion Trader:
Michael Greenbaum - O’Connor & Associates
As long as markets display such bipolar disorder and switch from periods of mania to periods of depression, then mean reversion should continue to merit worth as an investment strategy.
- James Montier
O’Connor and Associates used this market making style of trading to become one of the biggest participants in U.S. options exchanges in the ten years after their founding in 1977.
Their expertise in options pricing and risk management led to Swiss Bank Corporation first forming a joint venture.
5 Facts About Mean Reversion Trading
1) Fundamental Analysis
Mean reversion traders need to have a solid understanding of economic fundamentals as exchange rates can diverge from the historical mean for long periods due to factors such as protracted trade imbalances, political uncertainty, poor economic policy and other macro-economic factors.
2) The Long Term Strategy
The Mean Reversion strategy caters better to long-term trading as there is a clearer picture of an average over a longer period.
3) Observe the Risks
A mean reversion trader must be careful to observe potential events that may adversely impact the currency trade. Such events have the potential to cause the exchange rate to diverge from the mean for long periods and significantly impair levels of capital.
Mean Reversion Arbitrage is often best deployed in cross exchange rates where two economies are closely aligned as significant deviation of the rate from the mean can quickly lead to a re-balancing of resources and an exchange rate re-alignment towards the mean.
Technical indicators can be a useful addition to the mean reversion trader to help them identify the turning point of a trend where the exchange rate has deviated significantly from the historical mean.
Mean Reversion Trading On MahiFX
Characterise the nature of the move
Step one is to look for any news that might be getting priced in.
Monitor your trade's price action from the trading area book charts
You can open the books and look at more detailed charts of the price action across all the pairs and across different horizons. Note the EUR/USD book chart shows hourly periods, while the GBP/USD chart shows 10 minute periods.
Navigate to the charts section
A useful chart for mean reversion trading would be one with multiple instruments comparing their returns over a defined sample period. The example below shows EUR/GBP, GBP/USD and EUR/USD performance over the last 9 months.
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