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Most traders spend their entire careers trying to predict the future.
They read the news. They study the charts. They follow the "experts." And after all that work? They still lose money faster than I lose my hair. Here's what the professionals figured out a long time ago... You don't need to predict anything. Because prices have a dirty little habit. When it moves too far from the average, it’s likely to snap back. This approach is called mean reversion trading. And it's been quietly working in the background while retail traders are busy arguing about MACD settings on Reddit. Here's a way to think about it... Think of a rubber band. The further you stretch it, the stronger the force that wants to snap it back. That's what happens with stock prices. When a stock drops too far, too fast, there's a gravitational pull that tends to bring the price back toward its average. Think of it like your wife's mood when you forget your anniversary. It drops fast, really fast. But eventually, with enough apologies, flowers, and promising to be a better husband (again), it reverts to the mean. The keyword here is "eventually." Sometimes it takes longer than others, and sometimes the flowers need to be more expensive. So why does mean reversion trading work? Well, markets are driven by human emotions. Fear and greed. Always have been. Always will be. When prices fall quickly, traders panic. Weak holders sell. The selling feeds on itself. It's like a stampede. One person runs for the exit, and suddenly everyone's running, even the guy who has no idea what's happening. But more often than not, the selling is exaggerated. It's an overreaction. The fear fades. Rational buyers step in. Price rebounds. Now, you might be wondering… "What if the stock keeps falling?" Great question. And this is where most traders screw up. Not every falling stock is a rubber band ready to snap back. Some rubber bands are broken. A stock that's been declining for 6 months isn't "stretched." That's not a dip, that's a cliff. (Kind of like my hair. It's not "temporarily thinning." It's gone. There's no mean reversion happening up there. My forehead just keeps making new all-time highs, breaking resistance levels I didn’t know existed.) So how do you tell the difference? Here are some guidelines: 1. The stock is in an uptrend. You want to buy when the stock is in an uptrend because the price is likely to continue higher. E.g. the stock is above the 200-day moving average. Think of it like checking if your wife is in a good mood before asking if you can buy another trading course. 2. The stock made a sudden drop over the last few days. This is your pullback signal. The rubber band is stretched. This could be as simple as the 10-day RSI below 30 or the price drops 5% over the last 2 days. 3. Hold for a few days, max. If the stock wants to make a bounce, it should happen fast, usually within 5 days. If not, it’s likely to chop around or worse, continue lower. So hold your trade for a few days, if it doesn’t make a bounce higher, exit. Anyway… If you’d like to learn more about such a trading approach, then join me at Stock Trading Secrets. Cheers, Rayner "my-hairline-never-mean-reverts" Teo |