The tendency of a stretched price to move back toward its average; the opposite approach to trend following.
Mean-reversion strategies sell strength and buy weakness, betting that extremes are temporary. They work in ranges and fail in strong trends, which is exactly when they feel most compelling.
Tools include rsi extremes, bollinger-bands, and distance from a moving-average or vwap. Because a stretched market can stretch further, hard stops are essential.
Example: a stock trades 12% above its 20-day average, its widest gap in a year. A mean-reversion trader shorts with a stop above the high, targeting a return toward the average, and accepts that in a real breakout the stop will be hit.
Original diagrams for the ideas on this page. Illustrative, not real market data.
VWAP and its standard-deviation bands. VWAP is the day's average price weighted by how much volume traded at each price, so it shows where the bulk of the day's business was done. The bands sit one standard deviation either side, and price here swings between them all session.Range versus trend. On the left price keeps bouncing between the same floor and ceiling, which is a range. On the right each high and each low is higher than the last, inside a pair of sloping lines called a channel.
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