Concept

Mean reversion is a concept in trading based on prices eventually returning to their mean or average level after a period of divergence or departure from the historical mean.

Traders deploying mean reversion techniques typically wait for assets to diverge significantly from their mean values and then place trades on the assumption the price will return to the mean at some point in the future- this is also known as re-coupling or convergence. There are several mean reversion based trading systems which use Median Grids (grids), Bollinger Bands or Keltner Channels as entry and exit methods. It is important to be aware of fundamental factors when deploying mean reversion trading techniques as a sustained move away from an assets historical mean could be driven by fundamental factors which may create extreme divergence.

The Median Grid is based on the principle of mean reversion. On higher timeframes price typically reverts to its mean figure. Trading based on grids is discussed extensively in Dirk Du Toit's book called 'Bird watching in Lion Country'.

This type of trading suits medium to longer term position traders. The Median Grid module provides an automated calculation based on the 28 day moving average of price action. The grid is displayed as the mean price with 4 standard deviation levels which have default values of -2, -1, +1, +2. The indicator is fully configurable and allows changes to:

• Moving average calculation period
• Number of standard deviations
• Line colors
• Line widths and lengths
• Label size and position

Benefits

The Median Grid Indicator is a useful tool for the longer term position trader who wants to see where price action is in relation to long term standard deviation. Traders would be looking for turning points at typically high levels of divergence from the mean, in other words, where price action is a long way from its typical average or mean level.