What represents a mean reversion and the benefits of the strategy
A mean reversion is a strategy for operations on the stock exchange, which is based on the principle that the value of the asset sooner or later reaches the average value. In other words, it is necessary to track the average price. However, it is also necessary to take into account other indicators, such as the level of return on the stock.
The average value can be a historical average value or return on the asset, or economic indicators of the development of a certain industry.
The principle of return to average assumes that the value or other important factor, which demonstrates the deviations of the historical average, in the long-term consideration begins to move to the equilibrium state.
Traders use trends more often than not, but the theory of returns assumes trading as a counterbalance to them. It refers to counter-trend strategies. The player who chooses this principle must find sharp fluctuations in the value of assets, paying attention in the first place to strong deviations from the average. Such fluctuations are most often short in time and volatile, so that after a certain period the price returns to its usual value. These changes provide an opportunity to profit from sharp movements in the value of an asset when it is generally quite stable.
It should be understood that there is no ideal strategy that would always bring profit. An unexpected rise or fall in the stock price, changes in peaks or minimum values can bring losses. For example, global events, new product launches, management scandals, lawsuits and other factors lead to fluctuations.
In addition, the very deviation of the share price from the average may strengthen in the market and last for a long time. In such cases, it is concluded that the company has started to develop in a different way, and the return may never happen.
The strategy requires the trader to be attentive and take into account many different factors. First of all, it should be understood that the principle of mean reversion is not used for one asset. Then, the result of the transaction will depend on price changes, as well as the state of affairs in a particular company. As a result, there is a risk of misjudging the capabilities of an asset.
Therefore, the best option would be to apply the principle for shares of different companies. In this case it is possible to analyze the movement of assets to compare their dynamics. However, in order to make an accurate statistical conclusion, it is necessary that these assets are products that replace each other. This will make it clear that the change in their value happens through the same mechanism.
When working with this strategy, it is important to analyze past data, especially those related to price fluctuations and the reasons for their changes.