Designing a Powerful Mean Reversion Trading Strategy

A Double Trouble Trading Strategy For Powerful Market Reversals

Sofien Kaabar, CFA

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Mean reversion is a concept in technical analysis that suggests that prices tend to revert to their historical average over time. In other words, when a price deviates significantly from its average value, there’s a tendency for it to eventually move back towards that average.

For example, let’s say a stock’s price typically fluctuates around $50, but due to some event, it suddenly jumps to $70. According to mean reversion theory, there’s a likelihood that the price will eventually move back closer to $50.

This article presents a strategy that combines two powerful technical indicators to generate reversal signals.

A Refresher on K’s Reversal Indicator II

K’s Reversal Indicator II uses a moving average timing technique to deliver its signals. The code is available on TradingView, so do not burden yourself with the calculation. The method of calculation is as follows:

  • Calculate a moving average (by default, a 13-period moving average).
  • Calculate the number of times where the market is above its moving average. Whenever that number hits 21, a bearish signal is generated, and whenever that number if zero, a bullish signal is generated.

The following chart shows how bullish and bearish signals are formed (the yellow zone contains 21 bars that are above or below the moving average):

Signal chart

The following chart shows more signals generated from the indicator:

Signal chart

Important note

K’s Reversal Indicator II is available for free on Trading View. You can find it by typing its name in the indicator search bar.

On certain trending markets such as the S&P 500, it seems to handle it better than most contrarian…

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