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A Simple Mean Reversion Strategy

  • #21
  • Aug 13, 2023 6:52pm Aug 13, 2023 6:52pm
Quoting FireScape
"It's not so much about which specific tomato you want to buy, as much as it's about just buying the tomatoes when there is a high probability you can make a profit selling them at a "fair price". Most of the tomatoes are more than good enough. The ones that aren't are obviously rotten..." This reminds me of the M1 Countertrend Scalping Strategy. Hedging your bets that price will "eventually" return to its mean, but then we get into this on going debate about draw down.
And then I'll say the same thing again. 30% hard stop lol. And I was about to say that this reminded me of the M1 Countertrend Strategy as well, along with the Hedging Averaging Strategy.
Leave the Gun, Take the Armani
  • #22
  • Aug 13, 2023 7:09pm Aug 13, 2023 7:09pm
Quoting cliffjaded
{quote} And then I'll say the same thing again. 30% hard stop lol. And I was about to say that this reminded me of the M1 Countertrend Strategy as well, along with the Hedging Averaging Strategy.
hey brother

30% feels steep haha, that’s how you guys do it over there??!
Can't go broke making profit
  • #23
  • Aug 13, 2023 7:37pm Aug 13, 2023 7:37pm
@Riskcuit
Interesting thread but I must confess I've got lost.
How to calculate theta and all other probability parameters to make the right decision?
  • #24
  • Edited 8:17pm Aug 13, 2023 7:46pm | Edited 8:17pm
I’ve played around with this concept a lot, the theory of trading back to the 200 ema as mean and found a profound way to spot ideal times in the market when this would be most effective. I can share if OP permits.
Can't go broke making profit
  • #25
  • Aug 13, 2023 8:13pm Aug 13, 2023 8:13pm
Nice thread, RC.

How would you go about identifying the ideal "spread"? Finding the percentiles is easy enough, but how large is too large?
Quoting Riskcuit
you want to enter when the spread is large enough that there is a good amount of premium or discount, but not too large as this is often where the drawdowns will strike.
  • #26
  • Aug 13, 2023 8:14pm Aug 13, 2023 8:14pm
Quoting FireScape
I’ve played around with this concept a lot, the theory of trading back to the 200 ema as mean and found a a profound way to spot ideal times in the market when this would be most effective. I can share if OP permits.
Sounds like some seasoning I and I can imagine others wouldn’t mind hearing. Please just keep it in the context of the thread.
ri · skuht
  • #27
  • Aug 13, 2023 9:08pm Aug 13, 2023 9:08pm
Quoting carddard
Nice thread, RC. How would you go about identifying the ideal "spread"? Finding the percentiles is easy enough, but how large is too large? {quote}
That’s a great question, however, I want to note, there is no singular “ideal” spread.

It’s a dynamic position that you are adjusting/building into.

there are “non-ideal” spreads as mentioned earlier though, and it’s when spreads are small. We need to remember the spread is our potential profit, and it is usually decaying/shrinking.

Because of this, you don’t want it to be small.

Additionally, if you enter in really small spreads, the larger your VAR is, because when the market makes a run away from its “fair value”, which it will, you are closer to the beginning of that move.

As a good rule of thumb though, the larger the better, but you can’t sit around waiting to play the deviations that only happen 1% of the time. I mean you could, but it’s boring and you lose a lot in opportunity cost.

The reason the larger the better is because of how price is distributed. In a normal distribution, the probability of price touching a level in a certain timeframe is always 2 times the probability of price closing above that level in the same timeframe.

Markets are not normally distributed though as I have posted about many times here: https://www.forexfactory.com/thread/...heres-the-edge?

the main thing is, it’s fat tailed. And an interesting side effect of this is, the probability of touching prices beyond a certain range is usually more than 2 times the probability of closing above them. That structural fact about how price is distributed is very helpful for us.
ri · skuht
  • #28
  • Aug 13, 2023 9:12pm Aug 13, 2023 9:12pm
Quoting Riskcuit
{quote} Sounds like some seasoning I and I can imagine others wouldn’t mind hearing. Please just keep it in the context of the thread.
Awesome, this is just some personal seasoning, and some food for thought (no pun intended)

I too think the RSI is very powerful in mean reversion systems. I use it in a different way however. Most traders look for reversals when the market reaches oversold or overbought conditions. If you study the RSI you'll actually see it bounce off important levels quite bit. Traders rarely use it like this, but there's a lot of hidden potential within it that can really highlight the current strength of trends of whatever asset your trading. I believe however, at least in in the short term, when the RSI can finally break through the Oversold or Overbought level (no bounce) there's a true sign of strength, and when you combine this with the idea of "fair value" you can really start to see where price wants to go.

Here's an example...price breaks below the 200 EMA and starts trending downward for quite some time. If you notice - during this entire trend price doesn't break above the overbought level once (green line) - When it finally did cross, and when you take into account "fair value" it's evident that price will revert to its fair price or mean and you can take a position back to the 200 EMA. The problem with this concept is that the "Spread" will typically be very small in most setups, but you do get many trade opportunities. In the rare event price doesn't make its way back to the 200 EMA, then this is when you hit draw down and add another position at the next OS/OB level.
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Can't go broke making profit
  • #29
  • Aug 13, 2023 9:20pm Aug 13, 2023 9:20pm
Quoting Riskcuit
{quote} That’s a great question, however, I want to note, there is no singular “ideal” spread. It’s a dynamic position that you are adjusting/building into. there are “non-ideal” spreads as mentioned earlier though, and it’s when spreads are small. We need to remember the spread is our potential profit, and it is usually decaying/shrinking. Because of this, you don’t want it to be small. Additionally, if you enter in really small spreads, the larger your VAR is, because when the market makes a run away from its “fair value”, which it will, you are...
Thanks for the response RC, I appreciate it.
I was wondering if you could elaborate more on this point actually: "not too large as this is often where the drawdowns will strike" - How you go about identifying this, if that's what you were alluding to.
  • #30
  • Aug 13, 2023 11:13pm Aug 13, 2023 11:13pm
Starting to build a position in AUD/USD with the 15 min timeframe. The current spread is about 50+ pips so we have some pretty good margin to work with. Theta is roughly -1/2 pip and is accelerating. It could accelerate all the way to 1 pip. In other words, our potential profit is decaying at roughly 1/2 pip per candle. This means it will take roughly 50-100 candles to lose it all depending on how much theta oscillates.

When the trade moves against us, it accelerates, and it slows down when the trade moves for us.

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I will keep adding to the position as it moves down, but not super aggressively since the initial spread is so high. Deploying too much capital too quickly is just taking on excessive risk that can do more harm than good.

Will post updates as it develops.
ri · skuht
  • #31
  • Aug 14, 2023 4:18am Aug 14, 2023 4:18am
Makes sense to me , The arrow Indicator is basic RSI also
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  • #32
  • Aug 14, 2023 8:59am Aug 14, 2023 8:59am
Quoting Riskcuit
Starting to build a position in AUD/USD with the 15 min timeframe. The current spread is about 50+ pips so we have some pretty good margin to work with. Theta is roughly -1/2 pip and is accelerating. It could accelerate all the way to 1 pip. In other words, our potential profit is decaying at roughly 1/2 pip per candle. This means it will take roughly 50-100 candles to lose it all depending on how much theta oscillates. When the trade moves against us, it accelerates, and it slows down when the trade moves for us. {image} I will keep adding to the...
Overall, not much changed last night. Had a pretty good run toward fair value but has since reversed. Theta has eaten roughly 10 or so pips of our potential profit but we still have a good amount of meat on the bone.

Looks like the price will run further south so will probably add slowly as it does depending on how far it moves.
ri · skuht
  • #33
  • Aug 14, 2023 9:33am Aug 14, 2023 9:33am
Quoting FireScape
{quote} Awesome, this is just some personal seasoning, and some food for thought (no pun intended) I too think the RSI is very powerful in mean reversion systems. I use it in a different way however. Most traders look for reversals when the market reaches oversold or overbought conditions. If you study the RSI you'll actually see it bounce off important levels quite bit. Traders rarely use it like this, but there's a lot of hidden potential within it that can really highlight the current strength of trends of whatever asset your trading. I believe...
This is a very interesting way to enter indeed. I think the biggest issue is it's sort of a single-entry kind of thing. It probably works, but the biggest issue is, the spread is very small on entries, so your theta risk is higher. You winrate is higher, but so is your risk. This is always the balance you are striking. The higher the win rate, the lower your expectancy is and the higher your risk (both var and theta).

The higher the spread, the the lower your winrate, the higher your expectancy, and the lower your VAR and theta risk is.
ri · skuht
  • #34
  • Aug 14, 2023 11:23am Aug 14, 2023 11:23am
Quoting Riskcuit
{quote} case 2 is the definition of Theta. The rate at which our potential for profit dies. It’s usually working against us (90%+ of the time). This why the size of the spread is important. The more margin you have, the longer it takes the theta to eat your position.
Thanks for the clarification.
I understand that the entry is looking for a point at which the spread rises and with RSI in an overbought/sold situation, with this a large number of occasions may be in profit.
But what requirement or idea does he use for a second or more entries in case the benefit is consumed by Theta?, understanding that he maintains open positions and looks for the average of them until he leaves with a profit as a whole.
  • #35
  • Aug 14, 2023 2:39pm Aug 14, 2023 2:39pm
Quoting Riskcuit
Starting to build a position in AUD/USD with the 15 min timeframe. The current spread is about 50+ pips so we have some pretty good margin to work with. Theta is roughly -1/2 pip and is accelerating. It could accelerate all the way to 1 pip. In other words, our potential profit is decaying at roughly 1/2 pip per candle. This means it will take roughly 50-100 candles to lose it all depending on how much theta oscillates. When the trade moves against us, it accelerates, and it slows down when the trade moves for us. {image} I will keep adding to the...
Guess the term "Spread" in this thread means something else than normal meaning in trading
  • #36
  • Aug 14, 2023 3:11pm Aug 14, 2023 3:11pm
Quoting Merka
{quote} Guess the term "Spread" in this thread means something else than normal meaning in trading
You will want to read this post: https://www.forexfactory.com/thread/...1#post14533611

I'll be introducing some additional terms soon as we keep building on the initial concepts.
ri · skuht
  • #37
  • Aug 14, 2023 3:46pm Aug 14, 2023 3:46pm
Quoting Riskcuit
{quote} You will want to read this post: https://www.forexfactory.com/thread/...1#post14533611 I'll be introducing some additional terms soon as we keep building on the initial concepts.
Do you calculate all these probability values manually/auto before making the decision to enter or you just eyeball the charts to have a decent estimation of their values?
  • #38
  • Aug 14, 2023 4:12pm Aug 14, 2023 4:12pm
Quoting Riskcuit
Starting to build a position in AUD/USD with the 15 min timeframe. The current spread is about 50+ pips so we have some pretty good margin to work with. Theta is roughly -1/2 pip and is accelerating. It could accelerate all the way to 1 pip. In other words, our potential profit is decaying at roughly 1/2 pip per candle. This means it will take roughly 50-100 candles to lose it all depending on how much theta oscillates. When the trade moves against us, it accelerates, and it slows down when the trade moves for us. {image} I will keep adding to the...
Out of this position now.

Starting to build some in AUD/NZD, GBP/NZD, EUR/NZD, and USD/CAD
ri · skuht
  • #39
  • Aug 14, 2023 8:19pm Aug 14, 2023 8:19pm
Quoting FireScape
{quote} hey brother 30% feels steep haha, that’s how you guys do it over there??!
They don't. I do because i use riskier money management.
Leave the Gun, Take the Armani
  • #40
  • Aug 15, 2023 12:35am Aug 15, 2023 12:35am
So the system works with a $100 account and doesn't work with a $1,000,000 account? Or is there any value how big of an account do I need for 1 lot trades?

"I will dive deep into this later but what it essentially boils down to is this, you need volume to consistently make stable returns. Not volume in size, but volume in deals. This means you must do 2 things:

 

  1. Stay Small
  2. Trade Often


A short example to illustrate the point. Imagine a grocer who is selling tomatoes. Based on current market demand, they estimate they can sell $100 worth of tomatoes over the next week, and for every tomato they sell, they expect to make $1.00. But they have $3000 of cash.

Their expected value of each tomato transaction is $1.00, so mathematically, why not buy $3000 worth?

Even though they could try and buy $3000 of tomatoes to sell over the next week, the probability of $2900 worth of tomatoes going bad is so high, that it would be foolish to buy that much.
The expected value of the first $100 worth of tomatoes is very positive. However, the expected value beyond that point goes straight to -100%, the further you go beyond it, the fast you eat up the gains from the first $100 of tomatoes.

They have to stay small in tomatoes and use their money on other products."

Please excuse the bad English via Google Translate.
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