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The Myth Of Mean Reversion
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The Myth Of Mean Reversion

by The MoleApril 11, 2013

The ‘myth’ of that fabled mean reversion is that it always happens. However the problem is that it only happens most of the times. Confused – good? It’s healthy to shake up that old noggin’ every once in a while – to let go of some of those core beliefs that have done nothing but make your life a living hell trying to bank coin in the market.

It’s extremely important that you develop a sense of what market you are trading and I’m not referring to a sector, a particular type of market (i.e. futures, stocks, forex, etc.), or even symbol. More often than not fledgling retail traders do just fine for a few weeks or months and then suddenly get wiped out. Why? Well, they suddenly thought they knew something and that’s always a problem. But there’s another reason. Simply the market (correctly) claims that it reverses to the mean about 70% of the time which leads traders to start throwing around terms like ‘overbought’ or ‘oversold’. Oooh, that’s so sexy! You really sound like you know what you’re talking about, Mr. Hotshot Trader! Of course in the end we all know where this is heading – they suddenly lose and lose big. Reason being they keep holding red expecting mean reversion. And when she runs against you she often runs hard. Short squeezes are a trend trader’s bread and butter.

Truth be told my math skills are moderate at best but you don’t have a math genius to do this. In fact you can safely ignore all the fancy math involved and just look at a chart, then ask yourself – is this market trending? If the answer is yes and then some, well then you may just be yanking the tail of a leptokurtic market. Heck, it’s all fun and games until you get your hand bitten off. By the way we have covered this topic in much detail before – please refer here and here. Once again thanks to Volar for providing a lot of pertinent context including seasonality.

So why am I bringing this up again? Because I keep seeing those words pop up in the comment section again – you know who you are and I’m protecting the guilty (this time). Look the problem at hand right now is that we cannot know how far this puppy will run. Our P&F chart has pointed toward 1700+ for the past few weeks and I although I don’t think it’ll be a one-way run we just may get there by the end of the year. As of right now today equities are in ramp mode – there are no reversal cluster on our map, the volume profile is in virgin territory, and momentum charts have been flagging red for weeks (or maybe even months). And all that means nothing as long as people keep hating this rally – which is exactly why it has continued to relentlessly run higher.

This is how losers think – and have been thinking four years and counting now. I remember back in 1999 when Yahoo was the big dog out there and everyone hated it at 40 – then they hated it at 80 – and suddenly started loving it when it touched 100. It managed to climb into 125 and then dropped like a rock from there. Of course everyone suddenly thought it was a steal at 80, and then at 40, and then at 20, and finally as it approached 4 less than two years later nobody wanted to have anything to do with it anymore.

Seeing a pattern there?  Mean reversion my butt. Overboughtoversold – that’s just empty talk – absolutely meaningless. I tell you what – it doesn’t matter where it came from – all that matters is where it’s going. So look at your charts and don’t think about it in those terms – rather look at the context, the momentum, look at it as a living thing with a direction and potential hurdles in its path. If you can mix that perspective with a good sense of the prevalent sentiment then you are lightyears ahead of 99% of market participants.

Quick update on copper – I’m currently seeing two hammers and that’s interesting as that 25-day SMA has been holding up. I think the odds of a fence jump have increased but as of right now there is no reason to be long yet. However if we see that hammer breached tomorrow then we may get an attempt to climb higher. Until that happens the trend remains to the downside.

EUR/USD – it has now reached its 100-day SMA but has managed to hop over that weekly NLBL. That’s pretty bullish and if we see that daily SMA breach we probably see a run into 1.325 – which means my exchange rate will once again flush down the toilet. Remind me to raise your subscription rates!!

Cocoa also at its 100-day SMA – the weekly is touching the 25-w SMA. Possible reversal here and that shooting star on the daily is a possible harbinger of some downside. We’ll know tomorrow if we see its low being breached.

USD/CHF – I suggested this setup to my subs yesterday and it’s still in play – perhaps more so today even. I think the odds here are mixed – that hammer should have held and the fact that it’s retesting the SMA does mean there is more bearish pressure. If it gives way I want to be short.

GBP/AUD – very very interesting setup. Yes, we have an inside day but if you watch carefully we may also have a Retest Variation Sell – the trigger would be a breach of today’s low tomorrow. A long breach means we probably run back to the top and that 25-day SMA holds for now.

It’s not too late – learn how to consistently bank coin without news, drama, and all the misinformation. If you are interested in becoming a subscriber then don’t waste time and sign up here. The Zero indicator service also offers access to all Gold posts, so you actually get double the bang for your buck.

Cheers,


About The Author
The Mole
Mole created Evil Speculator amidst the chaos of the financial crisis in early August of 2008. His vision for Evil Speculator is a refuge of reason, hands-on trading knowledge, and inspiration for traders of all ages and stripes. You can follow him and his nefarious schemes at various social media waterholes below.
  • Kerberos

    Not sure defending banksters will increase your readership.

  • http://ibergamot.blogspot.com/ i Bergamot

    I think you missed his point

  • http://dartht.blogspot.com/ Darth_Gerb

    every-time I hear Leptokurtic, I think of an old post Mole did.

    remember the words, they may be very important some day.

  • http://evilspeculator.com molecool

    Not sure dimwitted comments like this will increase your popularity here.

  • http://evilspeculator.com molecool

    I think he’s missing a beat.

  • BobbyLow

    LOL, I know you are probably kidding but our current banksters are pikers compared to the Granddaddy of them all. This is nothing new.

    http://en.wikipedia.org/wiki/J._P._Morgan

  • http://evilspeculator.com molecool

    Linked above – but it wasn’t me who brought that here, it was Volar. I hope he’s well wherever he is.

  • http://ibergamot.blogspot.com/ i Bergamot

    Big guy was a genius.
    He actually took out an insurance policy on Titanic.
    Risk management or variant perception?

  • http://dartht.blogspot.com/ Darth_Gerb

    Conspiracy theory.
    the plan was to drown the competition.

  • http://dartht.blogspot.com/ Darth_Gerb

    (I told you to keep your head down, well – I hinted.)

  • bdoone

    Mole: “we probably see a run into 1.235” s/b 1.325? Hate to correct the teacher but I am paying attention.

  • http://dartht.blogspot.com/ Darth_Gerb

    I was referring to this one Mole

    http://evilspeculator.com/?p=17042

    3 years, see – I remember lots of stuff.

    I am sure that back in 1987 the tape was pretty oversold as well and that many momentum indicators available at the time were pointing towards a correction. However, Mrs. Market was not in the mood and decided to continue downward in post haste. It was almost impossible to predict back then and it is equally impossible today.

  • http://ibergamot.blogspot.com/ i Bergamot

    Not a chance…;-)

  • http://ibergamot.blogspot.com/ i Bergamot

    +1

  • http://ibergamot.blogspot.com/ i Bergamot

    VIX 32
    Those where the days…

  • amokta

    Any one got a view of Uranium stocks – they seem to be depleted (excuse the pun). Mind you all commodities seem spent right now (excuse the pun). Once these things catch a bid, a chain reaction is possible (excuse the pun)

  • amokta

    Ok, are we in for a Ben Bernanke finish or will it be a case of Ben Dover?
    Mkt held up well today, but things can turn on the flip of a bitcoin

  • http://ibergamot.blogspot.com/ i Bergamot

    CCJ is basically a monopoly in that space
    DNN seems a best miner

    For industry view see URA – it will tell you all you need to know.

    Personally, I am a big bull on uranium and successfully participated in 2 last bull markets, tried to pick a bottom post Fukushima, but failed. Just recently had CCJ, but exited. Still not ready. Uranium bull markets come every few years, just have to be patient.

    Fundamentally this sector is a candy waiting to be unwrapped. Nuclear power stations are being build everywhere around the world, even here in US. For now there is plenty of uranium, but only because of russian recycling program, and japanese still putsing around. Next year we will know for sure if it will continue or not. I don’t believe a single word of news about this highly politically charged sector – always lies. Always.

    Watch list: http://stockcharts.com/freecharts/candleglance.html?NLR,URA,DNN,CCJ,STHJF,USU,URZ,UEC,urg,urre

  • Curiousmind3861

    EURUSD couldn’t hold 1.31..is it still bullish??

  • amokta

    Thanks for the insight, will watch and wait for signs of criticality :-)

  • http://evilspeculator.com molecool

    Hey, what are 100 pips among friends?

  • http://evilspeculator.com molecool

    Forget about the VIX – 291 comments?? Jeezz – I don’t get that many in a week now! Perhaps if I put up a few bearish charts? 😉

  • convictscott

    The current 6 day rally was driven off the lows with an extremely powerful one day move. This is one of the key indicators of a move with “legs” 5 our of the last 6 closes were bullish closes closing near the highs. The one day down was at the upper bollinger (so expected in context) and erased the next day. The last 6 days of bullish action have closed above the closes of the previous 23 closes of the downmove. It is due for a pullback (and caution is warranted because of the outside period today) but after a rally of character like this any pullback is a buying opportunity.

  • convictscott

    I’d love to be a bankster. Who wouldn’t!

  • AmazingLarry

    Been watching URZ, UEC and DNN for months. Only a tiny position in URZ that I’m just letting ride. No cute stories on the sector or anything, just raw chartage. Once they pop, they pop. End of story.

    There’s a good technical setup in DNN right now, though. Closed today a tick above the 100 and the daily NLBL. But it’s wedged and I don’t see super attractive target over head for me personally.

  • mrmik3

    quality not quantity amigo

  • http://dartht.blogspot.com/ Darth_Gerb

    at least do a pretcher-for-the-day. (mix things up)

    it would be Cathartic, you’ve got the humor.

  • Curiousmind3861

    Thanks Scott for the detailed explanation. What is an outside period day and why caution is warranted?

  • AmazingLarry

    LOL. Dude, you would not believe how many minutes during the day my mind reiterates almost verbatim some of the comments you made in today’s post. It’s “overbought” it’s “oversold” bla bla blah. Thank GOD we have retail to defend such addicting behavior and take the other side of the trade. Honestly, someone has to be standing there on the other side of the fence convinced all their bullshit and nonsense is real to validate all that which REALLY is real.

    FTR, don’t protect the innocent. You can save people money and a lot of pain. You can unwind the clutches of the feeble mind. Why? Because ostracism is an extremely powerful behavior modifier. I know this because Tyler knows this. Without Evil Speculator, I would have blown up my account by now. That’s a fact! I’m 100% proof positive that the only thing that exists in markets is set ups. The rest is total bullshit.

  • amokta

    Thanks. DNN seems to be the heavy-weight here.

  • http://ibergamot.blogspot.com/ i Bergamot

    Those “pops” are the problem. They need to base, pop and hold. At that point – cast your net wide, because its not a question if you will double your money, but how many times you will double.

    This industry had been doing this dance ever since 50’s.

    Have to finish bloodbath first – they are already penny stocks, jees…

  • AmazingLarry

    Again, that’s cute. Where’s a set up?

  • AmazingLarry

    What signs?

  • amokta

    I think this one might be a longterm visual plan rather than near-term set-up.
    Im still worried if everything will wash down further in the P3 thats coming (oh yes, i am waiting for Godot!)

  • mrmik3

    http://ibankcoin.com/flyblog/2013/04/11/the-dollar-is-backed-by-power/

    what a crock of shit!!.. cept for the bitcoin part

  • Kolt_P

    Higher high and lower low than the previous bar. Caution because outside bars tend to show up at or before market turn. Considering what Scott just wrote, then a pullback (profit taking by guys who are long from lower and the need to suck in some new bears in order to shoot higher) would be nice.
    ———————
    “Well, they suddenly thought they knew something and that’s always a problem.”

    “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” – Mark Twain

  • http://ibergamot.blogspot.com/ i Bergamot

    Thats exactly my point

    There is none, ATM

    Just watching and waiting

    Actually this a very good example of obscure and temporary unpopular industry. This always has a tendency to wear-out an overactive trader, and after years of losses trader decides that they “all go to 0”, deletes watch list, following that new bull market starts. But the trader doesn’t know. Nobody tells him and there is no news to direct his attention. Happened to me more than once

    So I keep an eye out
    Luck favors prepared
    he-he

  • AmazingLarry

    Still don’t get it. Don’t see how any of it is relevant. What do you think of the DNN set-up I just posted?

  • http://evilspeculator.com molecool

    Possible Retest play on hourly EUR/USD.

  • grednfer

    1700? Whoa! You should post that “ragin bull” chart.
    Everybody get bullish when the market’s ripping up…..the volume to me looks like they’re in distribution mode.
    This weeks +50 S&P points rally is extremely rare….< 2% occurence over past 15 years.
    It most often occurs at the beginning of a new rally (from low with high vix) or ….. at the end of a rally.

    This rally is in the 15th week…..average is 7, last was 18, longest was 22……… We'll see
    …..but the MM dudes were selling outbound 1620s and 30s calls yesterday and today.

    I don't understand the relevance of your bell curve mean reversion model…….could you explain?
    The market moves in asymmetric chaotic sine waves…..your multi-moded BB charts are a great example of this theory and there is ALWAYS mean reversion…you can see it on every chart.

  • http://dartht.blogspot.com/ Darth_Gerb
  • convictscott

    Rubbish.

  • convictscott

    Outside period is a bar with a higher high and a lower low than the previous bar. ie a bar which is completely OUTSIDE the previous bar. Since a lot of traders cluster both buy and sell stops at daily highs, when you see an outside bar you should think “longs got fucked AND shorts got fucked”

    What this means is that when the existing traders get fucked out of their positions there are a whole bunch of new participants in the market, new participants are weak hands. Weak hands run for cover at the first hint of rain. Think about it, a trader long from 1.28 is very comfortable with a pullback from 1.31 to 1.30, whereas the same pullback for a trader long from 1.3050 makes him sweat bullets.

    IMO outside periods are of little import in a sideways market (because you can expect a tug of war around the mean with choppy trading) however in a trending market most often an outside bar represents at least a temporary end or pause to the move within a few bars (3 bars before a turn is the most commonly written about).

    In this instance in context I think the EURUSD has tipped it’s hand and wants to go up, the character of this move is very favorable for the bulls. However I would not get long here, but wait for a pullback.

  • convictscott

    Looks very good to me, but if it hits your stop you could consider reversing and going short

  • http://evilspeculator.com molecool

    what Scott said

  • http://evilspeculator.com molecool

    Funny – he said those rallies are extremely rare. Then he said it’s been rallying 15 weeks.

    By the way – the P&F is a LONG term chart – read my post again.

  • convictscott

    How could you not love that guy! He’s the most consistent asshole on the internet. Actually he is a very good trader.

  • http://evilspeculator.com molecool

    BTW – ~70% does not equal always. Neither does 99% – it’s that last percent that gets ya.

  • convictscott

    Things currently on my radar. Potential long in gold/silver. Long eurusd but waiting for a pullback, short AUD from higher up (not yet). USDJPY a watching brief.

  • http://evilspeculator.com molecool

    Agreed. About bitcoin – too early to tell as there’s no liquidity.

  • mrmik3

    Never really heard of him? Why do you think he is a good trader? From what I read not my cup of tea

  • convictscott

    I made a pile of cash out of bitcoins, but sold out @48. Its an incredibly good idea which is having its primary purpose corrupted. All bubbles pop and what is happening in bitcoin is incredibly bad for it. You can’t sell anything in bitcoins because of the volatility (you cannot have a merchant selling a laptop computer for $1000 in bitcoins and getting $500 one day later). So its no use except as a speculation vehicle. 80% of the BTC traffic goes through one exchange (mtgox.com) so a DOS attack can cripple it.

  • Th3_Acist

    Pulled all USD/JPY longs waiting across the hump at 100.13, simply not worth the 20 pips waiting. I feel like it’s got one more day to punch through or we might see a good size slide.

  • http://ibergamot.blogspot.com/ i Bergamot

    I will explain.

    You got yourself a nice set-up. Symmetrical triangle, 3rd touch of diagonal, good buy volume in January. All good, you’ll get your 20% or more with not much risk (if the low holds). Sincerely, wish you best of luck.

    My approach to these types of highly speculative and volatile industries is a bit more long term. For whatever reason, ones these little suckers get going they REALLY go. I remember one of my uranium positions in 2010 go from 5 to 30, and the high was even higher than my exit. They did it before 2010 and they will do it again. In between – I just get chopped to death (I am not a very good trader)

    For now – here is my long(er) term chart of DNN. Based on that – there is nothing going on. It’s ok, I’ll wait.

    This is only my personal method. Doesn’t have to be right, as long as it works

  • Kerberos

    I would prefer to remain the son of Satan than to become a lowly bankster.

  • convictscott

    Not mine either, he is typical of a lot of actual stockbroker traders, building a portfolio, taking strong views, etc. I’ve followed him for several years and he has extremely big balls, he rides his winners and pyramids into massive positions. He also knows when to cut the bleeding.

  • convictscott
  • Skynard

    Good set-up on AUD sitting at the 25 hourly, took it short with stop/buy at the NLBL. Seems to be taking heat after the data last night. Missed Kiwi today tagging 100 weekly BB.

  • mrmik3

    .. its funny cuz its exactly what the first chart is showing !! HAHA

  • convictscott

    What is low about them? Working for enormous compensation in the most interesting industry on earth. Playing with truly mind boggling sums of money. Playing the game against suckers like you and taking all their cash. The market has no morals, it just is. Markets have been manipulated for over 300 years. If you don’t know that you don’t deserve to have any money. Technical analysis is NOT about reading charts, but about ascertaining the intention of the big money. Big money leaves big footprints. Big money nearly always wins, so all our efforts at divining the market should be about divining what the big money is doing.

  • convictscott

    FWIW I have a valid sell setup if it breaks the daily low without breaking the daily high.

  • mrmik3

    .. yup this is bad for BTC!!

  • AmazingLarry

    I didn’t take the trade, just posted it.

    Second, I’m not opposed to your methods or your goals. I’m interested in the entry. Where and when? Better yet, how? By which metrics? Blind faith? Prayer? Throw a dart? Study the “fundamentals” like the market cares you think you know something. Seriously.

    I’m kind of like Scott in that I stock trades. I don’t have his skill set but I know there must be rules. Trust me, I know how things can run after you get off the bus. I’m the wise guy who bought THE bottom in NFLX at $53 on a technically valid entry and banked coin until stopped out. Now look at that fucking thing! The nice thing is that I really don’t care if it went to $1000 or $1 the next day because it’s not my concern. Just one example of many. But man, sometimes it can burrrrn.

  • Th3_Acist

    I have yesterday as an NR7 Inside day, was going to use the low as entry point…but I think I like your idea better.

  • Curiousmind3861

    Thanks for the education here. Priceless, where do you think is a reasonable spot to get in? might be slightly below 1.3 to scare all the weak hands?

  • mrmik3

    .. so what now and back up?

  • Skynard

    Let’s see some movement with bucky in a half hour. Will wait for the 100 and a re-test before adding at resistance. Stops are in so have a J&C:)

  • grednfer

    This weeks +50 point rally……meaning “in a single week” has only occurred 16 times in the past 15 years…..2%.
    I brought up the length of the rally cuz we are probably closer to the end than the beginning.
    I won’t say why the MM dudes are selling the calls, but you can go back and count…….
    …..in the past 800 weeks how many times has the S&P exceeded +35 points the week after a +50 week.
    ….smart money chases returns where risk is near 0.
    But how do you use the bell curve? That was my question….the other stuff was a gift.

  • mrmik3

    .. chuggin along!

  • FSUinArizona

    SLV with a move above 26.91?

  • http://ibergamot.blogspot.com/ i Bergamot

    I promise to post here when I will take any uranium positions in a future, along with entry and stop.

    In order for one of my “ideas” to work, there have to be some evidence on this URA weekly chart. Higher low (check), weekly close above 6.60, followed by higher high above 7.70. No negative divergence on daily oscillators would be nice, but I don’t give those much weight. All this have to be accompanied by improving volume profile (its a different chart) and hopefully very little news.

    If all this start happening, I will be increasing this core URA position and look to buy dips in leading individual stocks.

    You understand that none of this is happening at the moment, and i wouldn’t hold breath for this fantasy. But this is my method in a nutshell

  • mrmik3

    haha

  • http://www.facebook.com/nils.meyer3 Nils Meyer

    Say hello to your dad for me, will ya. Looking forward to our next strategy session.

  • convictscott

    its actually quite a rare buy setup which i have never posted before. if i get time ill do a post on it

  • Curiousmind3861

    a question about P&F chart, I see mole’s chart has a price target of 1710, but why is it when I use the P&F from stock charts, it is showing a target of 1800??? what am I missing?

  • AmazingLarry

    I’ve never understood it either until I adjusted according to his settings. “User defined, 5 pt, 3 box, reversal.” Adjust those and you’ll see 1710. Play with other settings and you’ll get totally different numbers. Don’t understand P&F’s well enough to know when to chose those settings.

  • ds2

    Why is my P&F chart different than yours?

    http://stockcharts.com/def/servlet/SC.pnf?c=$SPX,P&listNum=

    Says triple top breakout, not double. Price Obj is 1800. Does not show a Preliminary PO

  • Rightside_ot_trade

    Stalking rose currency and cocoa setups . Completely missed the reverse up past few days in cocoa

  • http://twitter.com/crashof2008 crashof2008

    I just woke up and saw red on the S&P am I dreaming LOL. This market cannot go down.

    There is a UPWARDS channel on the daily S&P that is quite strong => http://bit.ly/12OOs6A

    I think there are 3 things at play.

    1) Too many people go bearish.

    2) Funds being pumped into asian markets needed to go somewhere? SO dumped into our US markets, instead of the emerging markets.

    3) many people are saying “do not fight the fed” as ben bernanke now has a hobby of PRINT….PRINT….PRINT LOL.

    We be interesting to see what happens next week and when the big bank report on FRIDAY.

  • convictscott

    You should not choose a target to get in on the downside, the character and form of the retrace which has not started yet will tell you the story. Wait for price to go all the way down and then start rising again.

  • convictscott

    I get it, and it makes perfect sense :)

  • convictscott

    Actually I have steered you false. I checked and it wasn’t a sell setup or an NR7 inside day :) sorry

  • Skynard

    Doesn’t happen very often, even I know that. Unless you are in a bear market, remember those days? Something smells fishy:)

  • http://ibergamot.blogspot.com/ i Bergamot

    Yours is “traditional” scale. You can change it to “user defined” with box size of 5 .
    Play around with settings in “chart scale” section – you’ll be surprised.

  • http://evilspeculator.com molecool

    ¤ø„¸¸„ø¤º°¨¤ø„¸¸„ø¤º°¨ 
    ¨°º¤  S H A K E   N ¤º°¨ 
    ¸„ø¤º° B A K E !“°º¤ø„¸
    ¸„ø¤º°¨¤ø„¸¸„ø¤º°º¤ø„¸

  • http://evilspeculator.com molecool

    Guys – I strongly recommend READING the stockcharts.com tutorial. It shouldn’t take you more than an hour and then all your questions ought to be answered.

  • DarthTrader

    I would say he is not “Defending” Banksters as much as pointing it is foolish to trade as if they are not in the market . . . Deal with what is

  • ds2

    Thanks. Still getting used to P&F