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Ranking Stocks and Markets by Trend/Mean-Reversion Tendencies

February 18, 2010

Most traders have a strong preference for trend or mean-reversion strategies but rarely both. Sometimes markets trend, sometimes they mean-revert. The periodicity of this behavior is also distinct whether you are looking at the short-term or long-term time frames. When markets change, if you only employ a specific style you will underperform–this is guaranteed. The are only two solutions: 1) is to diversify by strategy and time-frame 2) is to find the best markets that suit your style at a given point in time–if the broader market isn’t trending for example (and you are a trend trader), then find a stock, commodity or ETF that is trending well. The real question is how to identify such situations– do markets or stocks have long-term or short-term tendencies that can be extrapolated reliably? The answer is a resounding–YES! It is possible to identify markets that are best suited to mean-reversion or trend strategies. The Livermore Index is one good example of a methodology that identifies trending stocks, but also looks at relative performance. However, as we shall soon see, the method is applicable in both directions–to also identify mean-reverting stocks/markets.

coming soon!

3 Comments leave one →
  1. QuantPlus permalink
    February 20, 2010 4:50 pm

    A generalist approach to mean-reversion is sub-optimal…
    As are virtually all generalist approaches…
    But giving people a single number or a small list sells, I suppose.

    Exploitable mean-reversion can be magnified dramatically by screening out custom universes from very specific niches. To use a poor, but illustrative, example… a universe of 50 SELECTED gold stocks that correlate highly with an external variable (price of gold)… would bounce around, then mean-revert following any gold price shock. The fact that this universe of 50 stocks reacts in a Normally Distributed manner to shock… creates, *** by definition ***, short to medium term mean-reversion (hours to days).

    Right now, a more interesting universe to build to exploit mean-reversion might be securities highly correlated to NBG and friends. That would be a very inefficient group… prone to schizoid behavior followed by exploitable mean-reversion.

    But it’s important to point out that Quant Analysis such as mean-reversion can account for, at best, roughly 50% of profits. If you are not exploiting a decent bid-ask spread and cannot play short-term, hi volume scalping Market Maker in your mean-reverting stocks… then you are leaving waaaay too much on the table to have a viable Business Model.

    • Josh permalink
      April 3, 2010 11:56 pm

      Oh thank you QuantGod for showing us the error terms of our ways….

      [ ] sincerity
      [X] sarcasm

      • david varadi permalink*
        April 4, 2010 12:11 am

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