Intraday Mean Reversion Strategies:
What is the logic behind mean reversion strategies?
The price of the asset whenever extends far from the true value i.e. either on the downside or the upside. The market participants tend to accumulate if it is undervalued or exit(or short sell) if it is overvalued. The buyers or sellers exploit the opportunities till it is back to their true value. This trading strategy is known as a mean reversion strategy.
In such a scenario, the market structure plays a very important role. For example, mean reversion strategies work best if the asset has the tendency to trade in a range. On the other hand, mean reversion strategies have a lower probability of success in the trending market.
In technical analysis, the following two indicators are used to identify the huge diversion of value to deploy the mean reversion strategy:
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a. Bollinger Band
b. Relative Strength Index (RSI)
a. Bollinger Band
A Bollinger Band is a momentum indicator that displays two standard deviations above and below a simple moving average in technical analysis. It gives traders a sense of where the market is heading based on price movements It employs three bands: one for the upper level, one for the lower level, and one for the moving average. When prices approach the upper band, it indicates that the market has become overbought. When prices end up moving closer to the lower or bottom band, the market may be oversold.
b. Relative Strength Index
Relative Strength Index is a technical indicator used to identify overbought and oversold market conditions. In most of the scenarios, if the RSI index is above 70 it means the asset is in the overbought zone and if the RSI index is below 30 it means the asset is in the oversold zone.
Two Intraday Mean Reversion Strategy Setup with Entry & Exit Rules
a. Bollinger Band setup on 15mins timeframe
b. RSI + Moving Average setup on 5 mins timeframe
Bollinger Band setup on 15mins timeframe
Rules for the Short Sell Entry:
1. On 15 mins timeframe check 1st two candles closing outside the Upper Bollinger Band (if we get more candles closing outside the BB band then its better but at least two minimum candles are required)
2. Wait for any following candle closing inside the BB band (Signal Candle)
3. Take entry below the candle closed inside the BB band.
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Exit Rules:
Place Stop loss above high of the signal candle ( i.e. candle closed inside BB band)
OR
Close position 15 mins before the market closes
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Bollinger Band default setting: 20 Period MA, 2- standard deviation
Rules for the buy entry:
1. On 15 mins timeframe check 1st two candles closing outside the Lower Bollinger Band (if we get more candles closing outside the BB band then its better but at least two minimum candles are required)
2. Wait for any following candle closing inside the BB band (Signal Candle)
3. Take entry above the candle closed inside the BB band.
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Exit Rules:
Place Stop loss below the low of the signal candle ( i.e. candle closed inside BB band)
OR
Close position 15 mins before the market closes
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Bollinger Band default setting: 20 Period MA, 2- standard deviation
RSI + Moving Average setup on 5 mins timeframe
Rules for the Short Sell Entry:
1. In 5 mins timeframe the price is above the previous day's high
2. RSI reading is above 50 and declining from the overbought zone ( i.e. 70)
3. 5-mins candle closed below 20 periods Exponential Moving Average (Signal Candle)
4. Take entry below the low of the candle closed
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Exit Rules:
Place Stop loss above high of the signal candle ( i.e. 5-mins candle closed below 20 - EMA)
OR
Close position 15 mins before the market closes
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RSI default setting: 14-period
Moving Average default setting: 20- period EMA
Rules for the Buy Entry:
1. In 5 mins timeframe the price is below the previous day's low
2. RSI reading is below 50 and rising from the oversold zone ( i.e. 30)
3. 5-mins candle closed above 20 periods Exponential Moving Average (Signal Candle)
4. Take entry above the high of the candle closed
​
Exit Rules:
Place Stop loss below the low of the signal candle ( i.e. 5-mins candle closed above 20 - EMA)
OR
Close position 15 mins before the market closes
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RSI default setting: 14-period
Moving Average default setting: 20- period EMA
