Mean reversion
The tendency of a stretched price or ratio to move back toward its historical average. It is the mirror image of momentum, and often at odds with it.
Mean reversion is the idea that extremes tend not to last: a price far above or below its typical level often drifts back toward the average. Approaches built on it buy weakness and sell strength, the opposite instinct to trend following.
The difficulty is timing: cheap can get cheaper and stretched can stretch further, for longer than anyone expects. Momentum and mean reversion both appear in markets, on different horizons, which is why no single pattern is treated as reliable on its own.
Related terms
- MomentumThe tendency of assets that have performed well (or poorly) recently to keep doing so for a time, a well-documented pattern used by trend and momentum strategies.
- Trend followingA rules-based approach that raises exposure to assets in sustained uptrends and reduces it in downtrends, following the move rather than predicting the turn.
- VolatilityHow much an asset's price fluctuates over time. High volatility means larger swings. It measures turbulence, not direction, and it is not the same thing as risk.