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Mean reversion strategy is based on the theory that prices will revert to their average. When price deviates too far from moving average or historical average level, traders expect price to revert to mean. The strategy works best in ranging markets, suitable for counter-trend trading.
Identify deviation: Degree of price deviation from mean
Mean calculation: Use moving averages or other statistical methods to calculate mean
Overbought/oversold: Use RSI, Bollinger Bands etc. to identify extreme levels
Counter-trend entry: Enter counter-trend when price extremely deviates
Target mean: Aim for price reversion to mean
Mean reversion strategy suits ranging markets and range trading, in forex markets can be applied to currency pairs with moderate volatility. The strategy is particularly suitable for trading within clear price ranges. Daily and 4-hour charts are commonly used timeframes.
Works well in ranging markets; provides clear entry and target levels; can capture price overreactions; risk-reward ratio usually good; suitable for algorithmic trading.
May suffer continuous losses in trending markets; requires accurate identification of mean level; price may deviate from mean for extended periods; requires larger stop loss space; psychologically difficult to trade counter-trend.
When using mean reversion strategy, note: avoid using in strong trends; set reasonable stops to prevent continued price deviation; confirm market is in ranging state; don't enter too early; combine with other indicators to confirm overbought/oversold; watch market environment changes; stay flexible, exit promptly when trend forms.
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