Mean Reversion
Candlefocus EditorMean reversion works best when markets are less efficient, trading strategies that may take advantage of such market inefficiencies can be particularly successful over the long term. Several market forces can influence the mean reversion process, including investor sentiment, market cycles, and macroeconomic events. This theory assumes that securities and other assets don't always move in a straight line and that there will be upward and downward price shifts.
Mean reversion strategies can range from simple to complex. One of the more simple strategies is to buy a security when it is trending significantly below its long-term average price, and sell it when it is trading significantly above average. The more complex strategies may involve the use of technical analysis, looking for patterns in the price history and exit strategies that account for any potential changes in the market such as news announcements.
Another approach that investors may find useful is mean reversion across multiple assets. This involves looking at the relationships or correlations between different securities and commodities and understanding when one is trading significantly below or above the average to its peers.
The use of mean reversion can be an important tool used by investors to create profitable investment strategies. Although it is not a perfect theory and will not always ensure success, it can be a beneficial tool for those looking to take advantage of value investment opportunities.