Mean Reversion CFD Trading Systems
When it comes to trading CFD systems, you may like to trade mechanical systems or systems that
involve discretion. Whichever style you trade, you may have heard of mean reversion systems. Let's
talk about this type of system in this article, including how they work, what to look for, and what
mistakes to avoid!
Why trade mean reversion systems?
Firstly, why should anyone consider looking at a mean reversion system? If you trade other types of
systems such as long or short term trend following, you may want to diversify and add another
system to the collection to even out and to have more consistent returns, to protect against changes
in the market conditions.
The other reason is that many mean reversion systems have higher win loss ratios, as well as
relatively frequent and short duration trades, to give a smoother equity curve, making them
attractive to trade in itself.
What are mean reversion systems?
OK, so now you know about some characteristics of these systems, let's look at some mechanics.
When a stock or CFD drops below the mean, and strays away from the mean, then there is a
likelihood that it will return to the mean.
The trigger for entry involves a significant enough dip, in the case of a long trade. This can be based
on for example, the stochastic oscillator, the ATR (average true range), the Z score or the RSI.
But you want a stock that is actually trending up, for a long trade. So what you want is an uptrending
stock, that in the short term over the past few days is going down, and has dipped enough. So have
an entry criteria that looks at the recent trend or direction of the moving average.
Another key to a mean reversion system is volatility. In many markets, an increased volatility is an
indicator that there is significant movement in the stock and thus will revert back to its norm
You may place your entry for example at a price below the trigger event, to ensure a nice low entry.
The exit may be triggered by an adequate price movement up or on consecutive higher closes based
on chart patterns.
Usually you are out of the trade in several days, so it's usually short term.
Backtesting mean reversion systems?
When backtesting, check the consistency of returns, the drawdowns, the number of trades triggered
and the win loss ratio combined with the profit loss ratios.
Some systems have over 70% winners which are very unusual for trading systems, combined with
average profit loss ratio greater than 1, and even up to 1.5. This means that there is potential for
If you use a discretionary system, or even if you use a backtested one, forward test it.
What to watch out for?
The biggest mistake people make is to take too many trades when there is a major correction in the
market and there are lots of stocks triggered. If you are in say 12 trades, it is possible that they all
keep going down for another day or two before they bounce up.
If you have are overcommitted or have used too much margin, then you may get a margin call or
have to stop out of all your positions to result in a large loss. In a few days time, the stocks may
bounce back but of course you would have missed out on these profits.
And secondly, always test the system as different systems work in different markets.
There you have it.
So as you can see, mean reversion systems can be with high win loss ratios, profit loss ratios, short
term in time frame and can offer a good number of trades per month. For these reasons, they have
become quite popular. However avoid the pitfalls so that you get the most of these systems.
Kurt writes for The CFD Trader, where you'll find out all about <a
href="http://www.thecfdtrader.com/cfd-trading-systems.php">CFD Trading Systems</a>,
backtesting CFD systems and what to look out for in a good trading system as well as CFD broker or