Wednesday, March 24, 2010

The Challenge of Mean Reversion Reversals in the Stock Market

Note how often price in the ES futures has popped to a new high or low, only to return to the prior trading range (blue arrows above).

I explained a major reason why this "mean reversion" occurs in my recent post on algorithmic trading.

This has proven to be a major challenge for short-term traders, who find themselves faked out on seeming moves that reverse.

The first step toward adapting is recognizing that a jump to a new high or low may be a trap. We then need criteria that help us differentiate the traps from the genuine directional moves.

More on that topic of criteria soon to come.


Jyoti said...

Dr Brett,

Thanks for all your post, i just wait for them! this post is so true about the trap. If we see Market Delta today we can clearly see buying taking place in the ES(mainly 200+ contract sizes) as soon as we touched that overnight low.

On a separate topic is it possible to write on the blog regarding your trading screen setups.(how many monitors/charts/quotes/marketdelta screes etc...) Sorry if that post is already exists.

Thanks again for helping thousands of traders around the world with your valuable blog posts.

Soberba Insônia said...

I trade mini-contracts here in Brazil too. I´ve noticed that days like this, charts leaves some strange patterns i.e. strong candles with nice volumes that don´t evolve further.

So, when I recognize strange behaviours, I know what´s going to be about.

What do I do?

I reduce drastically my targets, and dont wait for retractions at all.

I know know.. I get just some crumbles.

But it´s a way I´ve found to participate and training fast executions in volatile days like these, which normally I dont even like to trade.