Mean Reversion Strategy
Buy stretched pullbacks inside a long-term uptrend using RSI and Bollinger Bands, and exit as price returns to its average.
Educational only. No strategy wins every trade. Backtest and demo-trade any setup before risking real money, and size every position so one loss can't hurt your account. Risk disclaimer
The idea
Prices that stretch too far from their average often snap back. Mean reversion buys short-term weakness in markets that are strong in the long term, and sells as price returns to normal.
Setup
- Market: liquid stocks, ETFs and stock indices work best.
- Chart: daily.
- Indicators: 200 SMA, 2-period or 14-period RSI, 20-period Bollinger Bands.
Rules
- Trend filter: price must be above the 200 SMA. You only buy dips in uptrends.
- Stretch: price closes below the lower Bollinger Band, or 2-period RSI drops below 10.
- Entry: buy at the next open, or on a close back above the lower band.
- Exit: sell when price closes back above the 20 SMA (the middle band), or after 10 bars, whichever comes first.
- Stop: a hard stop 2 × ATR below entry protects against a trend change.
Strengths and weaknesses
Mean reversion often has a high win rate with small average wins. The danger is the rare trade that keeps falling. That's why the 200 SMA filter and a hard stop matter: never average down into a losing mean-reversion trade.
Risk management
Keep risk per trade at 1% or less and don't hold several highly correlated positions at once.
Plan the trade before you take it
Check the reward-to-risk of your setup and size the position so a stop-out costs only what you planned.