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.