What Is Mean Reversion?
Mean reversion is the statistical theory that prices tend to revert toward their historical average over time. When an asset deviates significantly from its mean (measured by moving averages, Bollinger Bands, or Z-scores), the probability of a move back toward the mean increases.
How Mean Reversion Works
Mean reversion strategies buy when price is significantly below the mean (oversold) and sell when significantly above (overbought). Common tools include Bollinger Bands (trade when price touches or exceeds the bands), RSI extremes (buy below 30, sell above 70), and Z-score calculations using VWAP or moving averages. The mean acts as a gravitational center for price.
Why It Matters for Traders
Mean reversion works best in range-bound markets and can be devastating in trending markets. The key is regime detection — knowing when the market is ranging (mean reversion works) versus trending (momentum works). Combining mean reversion with regime filters prevents the classic trap of buying a falling knife that never reverts.
