Studies have shown that using Reversals And Mean Reversion Trading Strategy works best over a time horizon of around 3 to 18 months. Less than that, or longer than that, and you are more likely to see a reversal which can also be described as mean reversion or regression to the mean.
One study, from De Bondt and Thaler (1985), found that the biggest losers over a period of three to five years earned higher average returns over the next three to five years. Meanwhile, the biggest winners earned lower average returns.
In other words, they found persistent mean reversion over a period of three to five years.
Additional research has shown mean reversion can also occur on much shorter time frames.
There is also documented mean reversion in fundamental data like earnings and accruals, intraday data, volatility and in the aftermath of short selling.
Like momentum, numerous research has been done into the subject of reversals and mean reversion. Also, a number of mean reversion strategies have been detailed on this blog and in our research program.
The following equity curve shows a typical mean reversion system that we detailed on this website:
Mean reversion strategies involve looking for extreme price movements that are unusual and likely to revert back to more normal levels.
They can be explored on various time-frames and in various settings. The Reversals And Mean Reversion Trading Strategy is continually optimized within the InterAnalyst algorithm and plays a significant role in helping issue our Green and Red trade signals.