The theory behind Swing Trading (Mean Reversion) is buy low, sell high. When trading using mean reversion you are buying stocks that are very oversold (stretched rubber band) and then looking to sell them when they revert (bounce) to the mean. This type of trading typically has a higher win rate but smaller average gains. Our systems look to be ‘correct’ 70% of the time but the average win is only 5%.
This is your buy blood on the streets type of system. When everyone is panicking you will be the buyer. The typical trades lasts for 12 days as mean reversion is larger overnight than intraday.
In strongly up trending markets our mean reversion system does not place many, if any trades. It thrives in a high volatility bear market like 2007 to 2009 when mean reversion is much more prevalent.
When this system performs best:
- High Volatility markets
- Usually bear markets or large pull backs in Bull Markets
- Sideways markets that have high volatility
When this system perform worst:
- Low volatility markets (no trades)
- Strongly up trending markets (no trades)
This is a typical looking trade from 2014:
- There is a setup period
- If triggered you buy on open the next day
- A profit target is are generated
- Each day the profit target is recalculated until triggered
- Or one of the 2 other exits triggers a sell on open the next day
What does it trade?
For ASX mean reversion we only focus on a handful of stocks as these generate the best return overs time. They are chosen for their liquidity and has nothing to do with fundamental value. The reason we focus on liquidity is two fold: They are easy to trade and bid/ask spreads are low but mainly because these stocks bounce the fastest. If you are a large institutional investor and want to put money to work you need large cap liquid stocks to put a large amounts of money to work fast. These stocks offer that ability.