Mechanical Trading Systems: Pairing Trader Psychology with Technical Analysis

CONSIDERATIONS IN ANALYZING INTERMEDIATE-TERM MEAN REVERSION TRADING SYSTEMS

Because markets are range-bound more often than they trend, mean reversion systems tend to enjoy a higher percentage of winning trades than trend-following systems. But because our goal in trading a mean reversion system is entering at temporarily unsustainable levels and exiting at the average, our profit to loss ratios and overall performance often will be inferior to that experienced with successful trend-following systems.

This does not suggest that mean reversion traders are less successful than trend traders; instead, it clues us in to the fact that top-caliber mean reversion traders usually augment basic mechanical trading techniques with discretionary elements. In other words, mean reversion traders may need to incorporate elements that cannot easily be quantified into a mechanical trading, such as unsustainable emotionalism, government reports, wars, and natural disasters.

Achievement of Profit Target and Stop Loss on Same Day

When analyzing backtested results of intermediate-term mean reversion systems, there is a higher probability of the market reaching both the stop loss and profit level on the same trading day. Ideally an analysis of intraday data would show whether the trade was a profit or loss, but as of this writing, no data vendors offer 10 to 20 years' worth of intraday price history. As a result, in such instances I will assume that these trades were stopped out as losses.

Stop Losses ...