How Does It Work?
What is mean reversion?
Mean reversion strategy arises from the assumption that an asset’s price will tend to move towards its average price over time. Alternatively, price moves in an irrational way in the short term but in the long term it always comes back to test its mean. Watch our time lapse 24 hour video of mean reversion trading bot here
How does mean reversion strategy make money?
When you are using this strategy, you are betting on the price to move in either direction but ultimately have a pull back in the opposite direction. As we know in the market, nothing goes straight up and nothing goes straight down. Markets move in a stair case way when its trending. It moves up a little and down a little ultimately trending up or vice versa.
Mean reversion traders buy or sell into a pump or dump and average their entry prices. You can do this averaging in a few different ways. It all boils down to your multiplier.
How do we manage average price and multiplier?
Let’s assume you use multiplier of 1 which means that you will put the same order size over and over again. If you have 100$ to invest into an asset that’s priced in at 100$, you can strategize to invest 1$ (1%) every time the price of the asset goes down 1$(1%). It would yield the following scenario in a 10% dump.
- 100$ you invest 1$
- 99$ you invest 1$
- 98$ you invest 1$
…
8- 93$ you invest 1$
9- 92$ you invest 1$
10- 91$ you invest 1$
Even though the price has dumped 10% down to 90$ your average price is at 95$ because you have spread your orders. Regardless of your first entry at 100$, you were able to pull your average down to a 5% loss rather than 10% loss. Therefore, you have an edge on the people who entered the market anywhere above 95$. So, you can close your position in profit before many other traders get to break even.
Now let’s look at the scenario that where your average price would be if you used multiplier of 2 which is extremely aggressive.
- 100$ you invest 1$
- 99$ you invest 2$
- 98$ you invest 4$
…..
8- 93$ you invest 128$
9- 92$ you invest 256$
10- 91$ you invest 512$
This is a whole different money management and risk taking. However, instead of having your average price at 95$. Now, your average price is 92$ which is only 1$ away from the current price which is at 91$. As you can see, this is extremely aggressive but also it always keeps your average close to the current price.
Conclusion
There are many different ways to configure your settings to accommodate different risk levels. Each of the variables like order size, multiplier, order spread, opposite side coverage, take profit and stop loss. The possibilities are endless and it is totally up to you. Make sure to read the documentation here