Everything You Need to Know About Mean Reversion Stock Trading
Author: George Davis
If you’ve been trading in the stock market, you must have heard about mean reversion trading strategies. We share everything you need to know about it right here.
If you’re an experienced financial trader, you may have heard about mean reversion trading strategies, but you may not have understood them completely. Mean reversion is a trading method where you try capturing the correctional price after the price has shifted from its mean. In short, mean reversion strategies will assume that big moves in the market will reverse after some time. This article will share everything you need to know about mean reversion stock trading as an investor.
What is Mean Reversion?
Mean reversion is a concept in financial trading based on the concept called regression to the mean. It shows that normal events will follow extreme events, and things will even out over time. That means the further a value is from the mean, the higher its chances that it will revert to its mean in time. In stock trading, when a stock is trading at a higher price than its mean, you rely on it to revert to its original selling price before too long.
Why Mean Reversion Stock Trading Works?
Mean reversion stock trading works in the market because the stock price will always revert to its mean. The investors in the market participate based on their emotions, and the two main sentiments that govern the stock trading market are greed and fear. Whenever investors learn that the stock price is rising, they will rush to buy it to avoid missing out on this chance. That creates a situation where demand is greater than supply, which causes the stock price to shoot up even higher.
Investors will greedily invest in the stock as the price continues to rise until it reaches a point where they will start selling the stock. As more investors start selling their stock, it will create a unique scenario where the price will start falling and reverting to its mean. The demand-supply imbalance created will be corrected, and as the price continues to fall, investors will panic and sell the stock quickly, resulting in a mean reversion of the stock price.
The best part about mean reversion stock trading is that there are numerous strategies that investors can learn and use in the market. It gives them the chance to capitalize on the market conditions and results in massive profits for investors willing to take risks. Therefore, you must be willing to take risks and buy stocks before it gets a chance to revert to its mean price again.
1. OneMain Holdings, Inc. (OMF)
2. Haverty Furniture Companies, Inc. (HVT)
3. Celestica, Inc. (CLS)
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