Thread by @icanseeyourpix2

A Thread🧵on Mean Reversion and how it can help you in your trading journey.

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So Mean Reversion basically means when the price of the asset tend to converge to the average price over time.

Continued....

Here the asset could be anything like - Nifty, gold, bonds, any stock etc.

And the average could be anything like 20, 50, 200 day moving average.
So what happens is, price tends to test its average after spend fair amount of time away from it.

Let's try to understand it with an example.
So as you can see in this example, the price deviated very far from it's 200 DEMA, but at one point started consolidating and waited till the average caught up.

Mean reversion doesn't necessarily mean that the price will fall back to it's moving average.
It can just simply consolidate in a range till the average catch up.

As in this case, after the initial testing its 200 DEMA back in august 2020, the price shot up very quickly away from it's 200 DEMA.
Then what happened?
Price started consolidating in a range till its 200 DEMA caught up.

On the other hand, price can directly just fall down to the mean, just like what happened in the case of SEQUENT

So how can you really use it to improve your trading?

It helps in determining when to book profits ( Or at least partial profits)

Like when you're trading using daily time frame and for let's for few months.

And the price has deviated too much ( 80 - 100%) from its 200 DEMA, its a good time to book partial profits because someday price will go back to the mean and you don't wanna be caught up in that.

You can even use it in case of swing trading, let's say you're trading from few days to few weeks prospective.
Using 21 DEMA is a good idea.

For example, as in this case of TCS whenever the price deviated 5-7% from it's 21 EMA, it came back to test it.

But this does not apply to every single stock because just like everybody has a different nature, every stock has different characteristics like average daily movement, high beta - low beta, some news or fundamental trigger than can help them to stay deviated for a long time.

For example - In this case of KPIT TECH
price is 26% away from its 21 DEMA.
And in this case of BIRLASOFT, price is 10% away from 21 DEMA.

So in the end trading is all about being flexible and trying what works best for you.

Hope you learned something, thanks for reading.

@shubhfin @charts_zone @suru27 @VVVStockAnalyst