# Mean Reversion > Mean reversion trades bet that prices stretched far from their average will come back. Learn the signals, z scores, examples and the risk of fading strong trends. Source: https://learn.tradelabsai.com/strategies/mean-reversion/ Track: Strategies and Styles · Level: Intermediate · Updated: 2026-10-03 Publisher: TradeLabs AI (https://tradelabsai.com). Education, not financial advice. Cite as: TradeLabs Learn, "Mean Reversion", https://learn.tradelabsai.com/strategies/mean-reversion/ Mean reversion is the idea that prices, or the relationships between prices, tend to return towards an average after moving to an extreme. A mean reversion trader buys when price is unusually low relative to its average and sells when it is unusually high, expecting a snap back. It is the opposite of momentum: instead of buying strength, mean reversion buys weakness and sells strength. Both effects exist, at different horizons and in different conditions. ## Where mean reversion appears | Market or measure | Why it may revert | |---|---| | Short term stock moves (days) | Overreaction to news, liquidity demands of large traders | | Ranges in sideways markets | Buyers and sellers balance around value | | Spreads between related assets | Economic links pull them back together. See [Pairs Trading](https://learn.tradelabsai.com/strategies/pairs-trading/) | | Volatility | Spikes tend to fade towards long run levels. See [Implied Volatility (IV)](https://learn.tradelabsai.com/volatility/implied-volatility/) | | Interest rate spreads and valuation ratios | Arbitrage and fundamentals limit extremes over long periods | ## Measuring "stretched" - **Distance from a moving average,** in percent or in ATRs. - **Z score:** how many standard deviations price is from its average. See [Percentiles, Quantiles and Z-Scores](https://learn.tradelabsai.com/math/z-scores/). ``` z = (price - moving average) / standard deviation of price ``` - **Bollinger Bands:** price at or beyond bands set two standard deviations from the average. See [Bollinger Bands](https://learn.tradelabsai.com/indicators/bollinger-bands/). - **Oscillators:** RSI below 30 or above 70 on short lookbacks. See [RSI (Relative Strength Index)](https://learn.tradelabsai.com/indicators/rsi/). **Example: A short term reversion rule** A trader tests a rule on a broad stock index ETF: buy at the close when the 2 day RSI falls below 10 and price is above its 200 day moving average; sell when price closes above the 5 day moving average. The trend filter means they only buy dips within an uptrend. Trades last a few days and win often, but losers can be larger than winners. Suppose the backtest shows that 70% of trades win, the average win is 1.1% and the average loss is 1.6%. Expectancy is 0.7 × 1.1 minus 0.3 × 1.6, or about 0.29% per trade before costs. See [Expectancy](https://learn.tradelabsai.com/risk/expectancy/). ## Strengths - **High win rates,** which are psychologically easier to trade. - **Works well in ranges and choppy markets,** where trend strategies struggle. - **Clear reference points:** the average acts as a natural target. - **Diversifies** trend and momentum strategies. ## Risks - **Fading a real trend.** What looks stretched can keep stretching. Markets can stay irrational longer than a trader can stay solvent, as the saying goes. - **Large occasional losses** that wipe out many small wins. - **Regime changes:** relationships that reverted in the past can break. See [Structural Breaks and Regime Changes](https://learn.tradelabsai.com/math/regime-changes/). - **Catching falling knives** in stocks with real bad news. ## Making mean reversion safer 1. **Use a trend filter:** buy dips in uptrends, not crashes in downtrends. 2. **Use stops or time exits.** If price does not revert within a set time, exit. See [Time Stops](https://learn.tradelabsai.com/position-management/time-stops/). 3. **Size conservatively** because losses can be fat tailed. See [Fat Tails](https://learn.tradelabsai.com/math/fat-tails/). 4. **Avoid averaging down without limits.** See [Scaling In and Pyramiding](https://learn.tradelabsai.com/position-management/scaling-in-and-pyramiding/). 5. **Test for stationarity** when trading statistical spreads. See [Stationarity, Differencing and Unit Roots](https://learn.tradelabsai.com/math/stationarity/). ## Momentum and reversion together Research finds reversal at very short horizons (days to a month), momentum over 3 to 12 months and reversal again over 3 to 5 years. Many traders run both: mean reversion for short swings and trend following for longer moves, which tend to perform in different market conditions. See [Momentum Trading](https://learn.tradelabsai.com/strategies/momentum-trading/). ## Common mistakes - **Assuming every big move will reverse.** - **No stop or time limit.** - **Ignoring costs** on short, frequent trades. - **Using too short a history** to estimate the average and volatility. ## Frequently asked questions ### What is mean reversion in trading? The tendency for prices or price relationships to return towards an average after moving to an extreme, and the strategies that trade that tendency. ### What is the difference between mean reversion and momentum? Momentum bets that strong moves continue; mean reversion bets that extreme moves reverse. They tend to work at different time horizons. ### What indicators are used for mean reversion? Common tools include z scores, Bollinger Bands, short term RSI and distance from a moving average. Next, trade reversion between two related assets with [Pairs Trading](https://learn.tradelabsai.com/strategies/pairs-trading/). ## Continue learning - Next lesson: [Pairs Trading](https://learn.tradelabsai.com/strategies/pairs-trading/) - Previous lesson: [Momentum Trading](https://learn.tradelabsai.com/strategies/momentum-trading/) - Related: [Momentum Trading](https://learn.tradelabsai.com/strategies/momentum-trading/): Momentum trading buys assets that are rising fastest and sells those falling fastest. Learn the research, intraday and multi month methods and momentum crashes. - Related: [Range Trading](https://learn.tradelabsai.com/strategies/range-trading/): Range trading buys near support and sells near resistance while price moves sideways. Learn how to identify ranges, time entries and exit when a range breaks. - Related: [Pairs Trading](https://learn.tradelabsai.com/strategies/pairs-trading/): Pairs trading buys one asset and shorts a related one when their spread stretches, betting it will converge. Learn pair selection, hedge ratios, z scores and risks. - Related: [Bollinger Bands](https://learn.tradelabsai.com/indicators/bollinger-bands/): Bollinger Bands place bands two standard deviations around a moving average. Learn the formula, the squeeze, walking the bands, %B and common trading strategies. - Related: [Percentiles, Quantiles and Z-Scores](https://learn.tradelabsai.com/math/z-scores/): A z score shows how many standard deviations a value is from its mean. Learn the formula, its uses in mean reversion and pairs trading, and the pitfalls. - Related: [Stationarity, Differencing and Unit Roots](https://learn.tradelabsai.com/math/stationarity/): A stationary series has stable statistical properties over time. Learn why prices are non stationary, how to test with ADF and KPSS and how to make data stationary.