Detecting Spikes for Mean Reversion Trading

Using the Average of a Season indicator from our last post, this time we want to show you how to use this indicator for mean reversion trading.

On the chart below you see some wonderful trading opportunities are marked. Each time you should have been able to make some money trading a reversal towards the average. The trick behind this detection method is just to measure the distance between the season average and the current market price. As soon as this spread exceeds a specific amount, the market is ripe for a reversal.

Using market extrems for a mean reversion trading strategy

Setting up the Mean Reversion Trading Approach

The chart above shows the S&P 500 index on a 15 min basis. So first open this type of chart and apply the average of a season. Set the season to monthly or any other period which suits your trading horizon.

The next step would be to calculate the distance between the current market price and the average. Therefore apply the spread quotient indicator on the S&P and select the average as the second input.

To find out when this distance has got an extreme value apply the Bollinger Band indicator on this spread. Set the period to very long, 500 or 1000 bars, and the width of the band to something between 1 and 2 standard deviations. A lower standard deviation number will give you more trading opportunities, a higher setting will improve the quality of the signals.

 

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