Mean Reverting versus Non–Mean Reverting Approaches

Mean Reverting versus Non–Mean Reverting Approaches

The type of technical studies employed also depends on the approach taken by
traders and analysts with respect to their personal preferences and biases regarding
the action of price in the markets. Basically, traders either adopt a contrarian
or a momentum‐seeking type approach. Being more contrarian in their approach
implies that they do not usually expect the price to traverse large distances. In fact
they are constantly on the lookout for impending reversals in the markets. In essence,
they expect price to be more mean reverting, returning to an average price
or balance between supply and demand. Those that adopt the mean‐reverting approach
prefer to employ technical studies that help pinpoint levels of overbought
and oversold activity, which includes divergence analysis, regression analysis,
moving average bands, and Bollinger bands. They prefer to trade consolidations
rather than trend action. They normally buy at support and short at resistance.
Limit entry orders are their preferred mode of order entry. Conversely, being more
momentum seeking in their approach implies that they usually expect the price to
traverse large distances and for trends to continue to remain intact. They are constantly
on the lookout for continuation type breakouts in the markets.
In short, they expect price to be more non–mean reverting, where demand creates further
demand and supply creates further supply, both driven by a powerful positive
feedback
cycle. Those that adopt the non–mean reverting approach prefer to em
ploy
technical studies that help pinpoint breakout or trend continuation activity,
which includes chart pattern breakouts, moving average breakouts, Darvas Box
breakouts, and Donchian channel breakouts. They prefer to trade trends rather
than ranging action. They normally short at the breach of support and long at
breach of resistance. Stop entry orders are their preferred mode of entry into the
markets.