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Mean Reversion Strategy

Overextension → Revert to Mean

5m Entry
1h Range Regime
Counter-Trend
Z-Score Based

The Concept

In range-bound markets, price often snaps back after an overextended move away from a fair value proxy like the EMA or VWAP. This strategy captures these "rubber band" moves back to the mean.

Key Insight: This works best when the 1-hour trend state is RANGE. In trending markets, price can stay overextended much longer than expected.

Long Mean Reversion Setup

Buy the Dip — Price Overextended Below EMA

Price drops sharply below EMA(20), creating a Z-score ≤ -2.0. The reclaim candle confirms reversal.

EMA(20)Stop LossZ ≤ -2.0ENTRY

Short Mean Reversion Setup

Sell the Rip — Price Overextended Above EMA

Price rallies sharply above EMA(20), creating a Z-score ≥ +2.0. The rejection candle confirms reversal.

EMA(20)Stop LossZ ≥ +2.0ENTRY

Z-Score Calculation

z_ema20 = (close - ema_20) / stdev(close, 50)

The Z-score measures how many standard deviations price is from the 20-period EMA. Values beyond ±2.0 indicate overextension.

Entry Conditions

  • Regime— 1h trend_state = RANGE
  • Long trigger— Z-score ≤ -2.0
  • Short trigger— Z-score ≥ +2.0
  • Confirmation— Next candle reclaims prior high/low

Exit Rules

  • Target 1— EMA(20) on 5m — the mean
  • Target 2— EMA(50) or range midpoint
  • Stop Loss— Below swing low (long) / Above swing high (short)

When It Works

Range-bound markets where price oscillates around a mean. Works best during consolidation phases.

Watch Out For

Trending markets where price can stay overextended. Strong momentum can push through mean reversion levels.

Avoid When

During breakouts, news events, or when volatility is spiking. The 'rubber band' can break in these conditions.

Trigger Confirmation (Avoid Falling Knives)

Don't just buy because Z-score hit -2.0. Wait for deceleration + reclaim:

For Long Entry:

  1. Z-score reaches ≤ -2.0
  2. Next candle closes above prior candle's high
  3. OR price reclaims EMA(20) on 5m timeframe

For Short Entry:

  1. Z-score reaches ≥ +2.0
  2. Next candle closes below prior candle's low
  3. OR price breaks below EMA(20) on 5m timeframe

Strategy Variants

Trend Pullback Variant

Allow mean reversion long entries even in a 1h UP trend, but only target the EMA(50) instead of EMA(20), and use tighter invalidation. This catches pullbacks in trending markets.