Discussion of article "Simple Mean Reversion Trading Strategy"
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New article Simple Mean Reversion Trading Strategy has been published:
Mean reversion is a type of contrarian trading where the trader expects the price to return to some form of equilibrium which is generally measured by a mean or another central tendency statistic.
Many asset classes, even exchange rates, are observed to be mean reverting; however, this process may last for years and thus is not of value to a short-term investor.
Mean reversion should demonstrate a form of symmetry since a stock may be above its historical average approximately as often as below.
A historical mean reversion model will not fully incorporate the actual behavior of a security's price. For example, new information may become available that permanently affects the long-term valuation of an underlying stock. In the case of bankruptcy, it may cease to trade completely and never recover to its former historical average.
In finance, the term "mean reversion" has a slightly different meaning from "return or regression to the mean" in statistics. Jeremy Siegel uses the term "return to the mean" to describe a general principle, a financial time series in which "returns can be very unstable in the short run but very stable in the long run." Quantitatively, it is the standard deviation of average annual returns that declines faster than the inverse of the holding period, implying that the process is not a random walk, but that periods of lower returns are then followed by compensating periods of higher returns, for example in seasonal businesses.
The following Figure illustrates the example.
But how do we measure ‘too far’? We will try a very simple way based only on the position of the price relative to the moving average.
Author: Javier Santiago Gaston De Iriarte Cabrera