Scott Jackson

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What is mean reversion in trading?

Mean reversion assumes prices eventually return to an average or equilibrium level after moving too far in one direction. Traders using this approach identify overextended markets via Bollinger Bands, RSI, or statistical measures like z-scores. For example, if EUR/USD spikes 100 pips above its 20-day moving average, a mean reversion trader may short expecting a pullback. This strategy thrives in range-bound markets but is dangerous during strong trends, as “cheap” prices can get cheaper. To manage risk, traders often use wider stop-losses and smaller position sizes. Mean reversion provides high win rates but smaller profits per trade. It is favored by algorithmic traders who exploit short-term inefficiencies in stable markets.