🐋
Whale Trading

Mean Reversion Strategy Overview: Role Division with Trend Following

In this section, we cover Mean Reversion Strategies.

Assuming you have already seen through Probabilistic Thinking and Trend Following Strategy:

Mean reversion strategies step aside from here and focus on:

"How to utilize the tendency of prices to return to the mean or equilibrium point as a strategy?"

  • Not all markets always return to the mean,
  • But in certain environments, the pattern of "prices that went far out rolling back inside" statistically repeats frequently.

This article serves as an "Entrance Manual" that:

  1. Briefly summarizes the concept of mean reversion,
  2. Explains the difference and role division from trend following,
  3. Summarizes the common structure of the RSI Reversal Strategy and Bollinger Band Reversal Strategy covered in this section.

The diagram below compares:

  • Left: A box/gentle section where the price oscillates up and down based on the mean value (center line) and returns near the center.
  • Right: A strong trend section where the price moves away from the mean line and extends in one direction.

Mean reversion strategies fit better in the left environment, and trend following strategies fit better in the right environment.

1. What is Mean Reversion?

A common assumption from a probability perspective is this:

"Even if the price temporarily deviates from the mean, it is highly likely to return near the mean over time."

The "mean" here can be:

  • A simple arithmetic mean,
  • A moving average line of Moving Average,
  • The middle of a box based on Support/Resistance Basics,
  • Or a middle zone where the market has gathered multiple times, like an Equilibrium Zone.

The important point is that:

  • The mean in math textbooks and
  • The mean we use in the actual market

can be different.

Traders usually define "deviation from the mean" and "reversion to the mean" based on:

  • "Is this section a place where it can be seen as 'gone too far' based on the flow so far?",
  • "Is there enough room to roll back inside?"

2. Mean Reversion vs Trend Following: Different Edges

From a probabilistic view:

  • Trend Following targets positive (+) autocorrelation between returns. → "What went up goes up more", "What went down goes down more."
  • Mean Reversion targets negative (-) autocorrelation between returns. → "Reversals are likely to occur after rising too much", "Rebounds are likely to occur after falling too much."

It is more realistic to view these two not as concepts that deny each other, but as:

"Different edges working in different environments"

Simply comparing:

  • Trend Following

    • Goal: Eat the continuity of movement.
    • Strength: Catching one big trend can have a huge impact on the account.
    • Weakness: Frequent stop-losses in box/choppy markets.

  • Mean Reversion

    • Goal: Eat the reversal after excessive deviation.
    • Strength: Good for creating short R/R structures in box/gentle sections.
    • Weakness: Risk of continuous losses as it becomes counter-trend trading in strong trends.

In practice, a method is often used where:

  • The account is designed by dividing into two edges: Trend Following Axis + Mean Reversion Axis,
  • And distinguishing in which environment each edge should be turned on and off using environment filters like DMI/ADX and 60-Day MA Strategy.

3. Environments Where Mean Reversion Strategies Work Well vs Break Down

3-1. Environments Advantageous for Mean Reversion

Environments that are relatively advantageous for mean reversion strategies have the following characteristics:

  • Based on Support/Resistance Basics, the top and bottom of the box are clear, and the price travels back and forth multiple times within it.
  • Based on Moving Average, a section where the swing width stays within a certain range as the price moves up and down around the long-term MA.
  • Based on DMI/ADX, a choppy/range section where ADX crawls sideways below near 20.

At this time, the picture of:

  • Box Top + Overheating (Overbought) → Reversal Short Candidate,
  • Box Bottom + Depression (Oversold) → Reversal Long Candidate,

can be repeated relatively stably.

3-2. Environments Dangerous for Mean Reversion

Conversely, environments that are very dangerous for mean reversion strategies are:

  • Based on 60-Day MA Strategy, a trend extending continuously in the same direction above/below the MA-60 on one side.
  • Based on DMI/ADX, a section where trend strength is strong with ADX staying high above the baseline.
  • Based on RSI and Bollinger Bands, a structure where the oscillator stays in "overbought/oversold" for a long time, or pushes further without reversing after breaking out of the band.

In this section:

  • If you keep repeating counter-trend trading with the belief that "it will return to the mean someday",
  • It is easy to get caught up in a structure that is continuously pushed by the counter-trend, not mean reversion.

In conclusion, Mean reversion strategies can only be used in environments where the "mean" concept is meaningful. In strong trends where the mean keeps moving, the premise of mean reversion itself may collapse in the first place.

4. Common Structure of Mean Reversion Strategies

The tools covered in this section:

are different, but the structure is almost the same.

  1. Environment Filter

  2. Finding Extreme Zone (Overheating/Depression) Candidates

    • Overbought/Oversold based on RSI, Band Top/Bottom or breakout outside the band based on Bollinger Bands,
    • Sections where volume/sentiment is leaned to one side using VR, etc.

  3. Entry Trigger (Price/Pattern)

    • Based on Support/Resistance Basics, whether it is near the top/bottom of the box or key support/resistance,
    • Based on Candle Patterns, whether there are patterns suggesting actual reversal such as tails, inside bars, engulfing, etc.

  4. Stop-Loss/Target/Position Size

    • Measure volatility with ATR,
    • And apply the R/R, 1R stop-loss, and position size rules defined in Risk Management as they are.

  5. Strategy Switching According to Environment Changes

    • The moment the box breaks or ADX soars, you must be ready to fold the mean reversion strategy and switch to trend following mode.

To summarize, "The tools (RSI, Bollinger) are different, but the framework of Environment Filter → Extreme Zone → Trigger → Risk Management is the same."

5. Timeframe and Risk Management

Mean reversion strategies:

  • In too short timeframes (1 minute, 5 minutes, etc.), you can be easily swayed by noise + fees + slippage,
  • In too long timeframes (weekly, etc.), the time/volatility required for one reversal can become too large.

In this section, we basically explain with the combination of:

  • Daily: Environment Filter (Trend vs Box, whether it is mean reversion mode)
  • 4-Hour: Entry/Exit Timing, checking candle patterns/oscillators

as the basic unit.

And whatever timeframe you use, we premise until the end that it is difficult to protect the account whether it is mean reversion or trend following without:

  • Loss limit per trade,
  • Daily/Weekly max loss,
  • R/R criteria,
  • Position size calculation method

covered in Risk Management.

6. Roadmap of This Section: What Strategies Will You See?

In the following Mean Reversion Strategy section, we cover in order:

  1. RSI Reversal Strategy

    • How to view RSI Overbought/Oversold not as "counter-trend" but as "mean reversion candidate sections",
    • In which environments RSI reversal works and in which environments it is dangerous with Daily + 4-Hour combination.

  2. Bollinger Band Reversal Strategy

    • How to interpret Bollinger Band Top/Bottom/Breakout outside the band from a mean reversion perspective,
    • Structure managing volatility by combining band contraction/expansion and ATR.

Each strategy is:

If you look at the remaining mean reversion strategy articles with this perspective in mind, it will be much easier to understand Mean Reversion not as a single strategy but as one axis of the entire account structure.