Strategy 2: Mean Reversion
Buy low, sell high. This strategy works when markets are ranging, not trending.
When to Use
ADX < 20 (weak trend / ranging market)
The market is moving sideways, bouncing between support and resistance.
Entry Signals
Enter a long position when:
| Signal | Weight | Description |
|---|---|---|
| RSI < 30 | High | Oversold condition |
| Price at Lower BBand | High | At volatility support |
| Stochastic < 20 + Bullish Cross | High | Oversold with reversal |
| Williams %R < -80 + Cross | Medium | Fast oversold signal |
| CCI < -200 | High | Extreme oversold |
Ideal Entry Setup
✅ ADX < 20 (ranging market)
✅ RSI < 30 (oversold)
✅ Price at or below lower Bollinger Band
✅ Stochastic bullish crossover below 20
✅ CCI < -100 (preferably < -200)
Exit Signals
Take profits when:
| Signal | Action |
|---|---|
| RSI > 70 | Take profits |
| Price at Upper BBand | Take profits |
| Stochastic > 80 | Take profits |
| Price at Middle BBand | Partial profits |
| Williams %R > -20 | Take profits |
Target Levels
Entry: Lower Bollinger Band
Target 1: Middle Bollinger Band (50% of position)
Target 2: Upper Bollinger Band (remaining 50%)
Position Sizing
Smaller positions - Mean reversion trades have lower win rates but good risk/reward.
Ranging Market: 50% of intended allocation
Quick profits: Exit at first target
Risk Management
| Parameter | Value |
|---|---|
| Stop-Loss | Below lower Bollinger Band (1 ATR) |
| Take-Profit | Middle or Upper BBand |
| Max Risk | 1% of portfolio per trade |
| Hold Time | Short (days to 1-2 weeks) |
Example Trade
Stock: KO (Coca-Cola)
ADX: 15 (ranging market)
Entry Signals:
- RSI: 28 (oversold) ✅
- Price at lower BBand ($58) ✅
- Stochastic: 18 with bullish cross ✅
Entry: $58.00
Stop-Loss: $56.50 (below lower band)
Target 1: $60.00 (middle band)
Target 2: $62.00 (upper band)
Risk: $1.50 per share
Reward: $2-4 per share
Risk/Reward: 1:2 to 1:3
Key Differences from Trend Following
| Aspect | Trend Following | Mean Reversion |
|---|---|---|
| Market Type | Trending (ADX > 25) | Ranging (ADX < 20) |
| Position Size | Full | Smaller |
| Hold Time | Weeks to months | Days to weeks |
| Win Rate | Lower | Higher |
| Profit per Trade | Larger | Smaller |
| Stop-Loss | Wide (trend-based) | Tight (volatility-based) |
Common Mistakes
❌ Using in trending markets - Check ADX first! ❌ Catching falling knives - Wait for reversal confirmation ❌ Holding too long - Take profits at targets ❌ Position too large - Use smaller size for mean reversion
Next: Breakout Trading Strategy →