Mean Reversion Strategy | Podcast Episode #243

0:07
Hey, I’m Ryan Mallory, and this is my swing trading the stock market podcast. I’m here to teach you how to trade in a complex, ever changing world of finance. Learn what it means to trade profitably and consistently, managing risk, avoiding the pitfalls of trading, and most importantly, to let those winners run wild.

0:25
You can succeed at the stock market, and I’m ready to show you how. Hey everybody, this is Ryan Mallory with Swing Trade in the stock market. In today’s episode, we’re gonna talk about mean reversion strategies, and we’re gonna talk about a few other strategies as well that you might not have heard about, but the main emphasis is going to be on mean reversion strategy.

0:45
So today’s email comes from a guy who has picked out his own Florida redneck name. He wants to be called Delmont. Now I can tell you, living in Florida, I don’t know if I’ve ever come across a redneck named Delmont. Not sure if I’d want to, but nonetheless, Delmont writes, Hey, Ryan, I truly enjoy your podcast as it brings a very realistic perspective to something that has become recently and more than ever trendy.

1:12
He’s talking about the stock market, of course. He says, I had a few questions regarding mean reversions and how you could advise someone getting into that strategy. Now for the build up, I got back into trading in 2019 after the Bitcoin push took effect in 2016.

1:28
As I returned, I started to follow and join trading groups of a few gurus that introduced me to swing trading. I saw that this was a happy medium, as investing was too boring for my personality, and day trading was just too intensive. I followed a bunch of these gurus, he puts that in quotes, to no avail until I found one super trader.

1:48
Who truly taught his methodology without cost. From this, I have been focusing on two strategies breakouts and episodic pivots. I have spent hundreds of hours studying previous charts to see how the major movers of the last 6 years have set up.

2:03
The setups have been paramount to really learning how to properly manage risk, as well as soothing the overly emotional response to losing traits. The trading indicators I mainly use are the 5, the 10, the 20, and 50 simple day moving averages on the daily chart for trend aspect and for my exits, and for entries, I focus on the 5, 1020, and 50 exponential moving averages on the 15 minute time frame to capture the most optimal time to hop in my positions.

2:31
Here are my questions. As the current market is rather choppy, to say the least, I have heard this traitor that I follow mentioning how he got started in mean reversion during similar markets to this. Although he is phenomenal with the strategies mentioned above, he never goes into detail about the proper way to execute and maintain this strategy.

2:52
Do you think the mean reversion strategy to my book of knowledge is a move in the right direction, or should I just stay with breakout and episodic pivot strategies I am comfortable with? Number 2, if it is a good strategy to learn, I have noticed that the majority of the execution methodologies I researched seem to be rather high level and vague.

3:14
How would you advise learning more about trading a mean reversion strategy? Thank you so much in advance for your help and continue to do the phenomenal work that you have been doing as it is a ray of sunshine and those troubling times. Sincerely, Delmont. Now, what am I drinking today?

3:31
I picked up this new bottle this evening at Sam’s Club. It’s George Remus, King of the bootleggers straight bourbon whiskey. I don’t think King of the bootleggers is actually in the title. They just call George Reuss king of the bootleggers. This is kind of like a throwback to prohibition time.

3:49
It’s 94% proof, 47% alcohol. Never had it before. Some people say it’s good though, so I kind of curious about this one. Now, when I like, give it a good sniff, you know, I, I pick up a little bit of maple. Now, to the taste, a little bit of heat, but it comes across a little flat.

4:08
It’s also interesting too, like the color itself is almost somewhat flat. I don’t think that the color of this bourbon has like a nice rich color to it. You definitely pick up on a little bit of the vanilla flavor to it, but I don’t think anything about this particular bourbon stands out. Is it an everyday sipper?

4:25
Yeah, I think you can make it an everyday sipper. I don’t think it’s a great everyday sipper, but it’s an everyday sipper. And you definitely pick up on some strong rye flavors at the finish, but it kind of leaves you wanting more. So, I’m gonna say for this particular bourbon, I’m gonna give a 6.9.

4:42
I was hoping it would garner a higher score, but hey, it is what it is. It’s 6.9. Now, back to Delmont and his questions. So to recap, essentially what Delmont’s talking about here, he’s got two main strategies that he follows.

4:58
He trades breakouts and he trades episodic pivots. Now, if you don’t know what episodic pivots are, I can tell you a little bit about that in just a second. And now he’s wanting to add a third setup to his trading strategy, and that would be mean reversion. Definitely different than your breakouts and episodic pivots. But one of the things that Delmont’s doing right, and I think I can appreciate it when he talks about why he’s doing swing trading versus long-term investing or day trading, it’s because it fits his personality.

5:23
And that’s hugely important because you want a strategy that fits your personality. Most people think that you just need to do long-term investing, but that doesn’t always fit everyone’s personalities, and they end up making some really bad decisions like when the market’s tanking, they’ll sell everything at the very bottom and not get back in until the very top.

5:40
Yes, there’s a fear and greed element to that kind of behavior, but there’s also probably a good chance that long-term investing doesn’t suit their personality. Now you take somebody like Warren Buffett or Peter Lynch. Long-term investing definitely suits their personality for me. I can do long term investing, but I also have to have some swing trading that I’m doing as well because it, the swing trading itself allows me to be able to do long-term investing.

6:06
I put everything in different buckets. I have different accounts for different time frames of my trading. I have one for dividends, I have one for long term investing, and I have my swing trading, and I don’t let any of those mingle. In fact, my dividends is with a completely different broker. Because in the end of the day, I don’t want to log on and have everything in one bucket, and then start looking at, OK, all my long term positions are way down, but my swing trades are doing phenomenal, but I feel like I’m having a bad day.

6:31
No, maybe from a long term perspective you’re having a bad day, but if you’re trading from more of a short term perspective like swing trading, you’re having a great day. So it’s better to keep everything in separate buckets, at least it works that way for me. He also talks about, you know, searching for trading gurus and everything else.

6:47
I know guru is uh something that they’ve tagged on a lot of people. I always associate trading guru with somebody who just flaunts, you know, the how much money they have and trying to act like they’re an expert on the market and they’re never wrong. You rarely see them talk about their losing trades. If you’ve been listening to.

7:04
This podcast for any length of time, I don’t think anybody would necessarily call me a trading guru. I hope not, as I’d like to think of myself as just another trader with a lot of experience and a lot of knowledge to offer up, and of course a successful trader, but I definitely don’t like the guru label that some of these people tend to have attached to their name.

7:24
Because like I said, I mean, these are the people who are saying, oh, I’ve trade with tens of millions of dollars, I made my 1st $100 million trading this setup and I did this one with that setup. I really believe that the people who are usually saying that kind of stuff have nothing to begin with. Because you shouldn’t have to flaunt how much capital you’re trading with in order to be able to say that you’re a good trader.

7:44
It should be evident by the trades that you’re taking. If you’re having to talk about how many millions of dollars that you’re trading with, if you’re actually trading with them most of the time they’re not. I feel like that’s some kind of like compensation that’s going on there. You’re like trying to compensate for something else, probably the lack of or ability thereof to actually trade successfully in the stock market.

8:05
Now, Delmont trades two specific trading strategies, the first one being breakouts. Now, most of you guys probably know what a breakout is. It’s usually like a period of consolidation where there’s some resistance just above, it pushes through the resistance and in theory, there should be a lot of momentum that comes along with a lot of volume as it breaks out into new territory that it hasn’t been in before or at least hasn’t been.

8:24
And in a very long time, pushes through that resistance on strong volume and sees an acceleration of price. That’s. Kind of probably the most basic description that I can give on a breakout trade. Now, you have the episodic pivots, they’re a little bit different.

8:40
They’re news-based, people will trade them off for the first couple of minutes of trading. It’s very fast and very volatile usually because it usually is preceded by a period of calmness, then you might get like an FDA approval or a big earnings beat, and all of a sudden the whole paradigm shifts on the stock and it’s opening up like 20% higher.

9:01
And then you’re looking to see, OK, are we going to break the 5-minute highs or the 1 minute highs depending on the trading strategy or maybe it’s like the 1st 15 minutes or 30 minute highs, right? And then you get in at that point. A lot of times they’ll put their stop off just below the lows of the day.

9:16
So oftentimes that 1st 5 minutes can create a very large candle. So you’re taking a big risk many times, especially when they’re gapping up 20 or 30%. You might have a stop loss of 10% if you’re just playing the lows of the day.

9:32
So you’re expecting, you know, a huge surge of momentum right out of the gate. Maybe it pulls back for the first minute or two and then it breaks that high of the day. You get in, the volume is usually amazing, like 10, 15x normal volume readings, and it just takes off.

9:49
Thing is though, there’s a lot of people, I mean, a lot of people that trade those. Why? Because it’s usually confined to some of your lower dollar stocks, not like your Google’s or your Microsoft or Apple’s, it’s usually like stocks trading under $10.

10:07
So People are trading those are usually with smaller accounts. I’m not saying Delmont’s in this particular camp, but there might be trading with like a few $100 or $1000 or something, and they’re still caught up on how many shares that they can buy.

10:23
They don’t wanna only trade with one share or 3 shares or whatever. They want to be able to say they got 1000 shares of some stock trading at 10 cents a share. So episodic pivots is going to attract a lot of those kinds of traders, so there’s gonna be a lot of emotion and a lot of volatility in those places.

10:42
And the intraday price movements can become very unreliable because they will break the lows of the day, stop you out and go right back up to the highs of the day. So there can be a lot of frustrations that’s involved there too, which can lead to a lot of undisciplined trading and future trade setups because you’re going to have that recency bias or that.

11:01
Memory of how you were stopped out on a trade previously when it broke the lows of the day and you don’t want that to happen again because last time it went back up to all-time highs or, you know, 20 or 30% higher from there. So if you are gonna trade, man, it takes a lot of discipline, OK? But you also have to be willing to deal with a certain degree of volatility which can be quite enormous.

11:20
And now I’ll trade a lot of breakout plays, I’m not really a fan of episodic pivots. I think it’s a very difficult trading setup or strategy to be successful. I’m not saying that there isn’t people who are successful at it, but I think that the large majority of people are not successful at it.

11:36
So, Here comes Delmont. Whether or not he’s successful at those two trading strategies, he sounds like he is in his email. He wants to add a third setup and that would be the main reversion, completely different from breakouts and EPs. Mean reversion is usually like you’re fading a stock, maybe it might be like parabolic short places, right?

11:56
To where maybe it’s one of these EPs that have had a big news piece and it goes from $5 a share up to $25 a share in 10 or 15 days, and you’re thinking to yourself, man, this thing’s gonna come right back down. It has to, it can’t sustain this. It’s way too high.

12:13
The news doesn’t even merit it. So what do you do? You get short on the stock. Now, in theory, it makes perfect sense. Like you take GameStop from January of 2021. The thing was trading at like what, $480 something dollars a share.

12:29
Of course, everybody knew it was gonna come down. The problem was shorting it and not knowing where it would start to come down at. But let’s go back to the beginning with GME GameStop when it was trading at like $7 or $8 and then it goes up to like $50 and it’s hitting new all-time highs, and I’m thinking to myself, this is like buying Blockbuster in 2005 at all-time highs, thinking that it’s gonna keep going higher.

12:54
Well, it did. It kept going higher and higher and higher. It goes up to like 120 then 200 and you’re thinking to yourself, there’s no way this thing’s gonna keep going up. But it does. Now, shorting a parabolic stock that is defying the odds at 200 on paper makes sense, and eventually it’s gonna come back down.

13:13
And we all know it is. But the problem is, is like, at what point does it start coming back down? Because again, it didn’t start to come back down until it like reached $480 something dollars a share. And by then you’re getting margin called up the wazoo. You won’t even make it that long.

13:29
Yes, you can buy some puts and everything, but then you gotta hope that you’re right on the expiration. I did a video just recently on GameStop when they declared that stupid stock split thing. And I was like, guys, this thing is beyond dumb, OK? I would not buy this simply because they have a stock split and you’re gonna harken back to the days of Apple and Tesla when they did their stock splits and it’s like, OK, it’s gonna do the same thing.

13:52
It’s just gonna go straight up forever until they split their stock because it’s gonna be more affordable, yada yada. Well, guess what? It’s gone from like what, $200 down to $120 something dollars a cents. I mean, it’s basically been straight down. Since I did that video, and even at $127 guys, it’s absurd that it’s even still that high.

14:13
It should be down in the single digits. It’s a crap company. And I know a lot of people like Ryan Cohen, guys, one of the best things you can do as a trader is not to worship the CEO or somebody they have on staff there. Because then you could become completely disconnected from reality and you’re thinking almost like it’s gotta go back up.

14:32
They got the CEO. And all the while you’re bag holding it while they’re making you believe that there’s something that they’re probably not. Same thing goes for AMC way overvalued. And so you can short these parabolic stocks, but the problem is, is you’re essentially standing in front of a freight train hoping that it’s gonna stop before it gets to you.

14:54
Eventually it’ll stop, but it might be at a train station much further down the tracks, and it’s just gonna mow you right over. There’s other ways to do mean reversions, like one is Bollinger bands, right? You don’t know what Bollinger bands are, they’re essentially like standard deviations off of the 20 day moving average, you know, if you have a stock price that goes outside of the upper Bulger band or the lower Bollinger band, that’s like 2 deviations outside of it, right?

15:22
Or you can make your setting to 3, but usually it’s 2 standard deviations that most people care about. So then when it gets way outside of it, then people will start fading that move, whether it’s to the long side or to the short side, depending on the direction of stock, with the expectation that they’ll cover it back at the 20 day moving average.

15:40
And that can work too, but again, those bands can expand, while that rhymed, and the price can spend a long time outside of it. So once again, you got to make sure that it’s actually starting the legitimate breakdown and by the time you know it, and oftentimes it’s already getting really close to that 20 day moving average already, but there’s tons of different ways to play mean reversions.

16:02
I’m not a huge fan of them. I mean, you take Netflix, for instance, right? I mean, it had a trend line going back to 2013. It was consistently pulling back to and popping off of and then it was like 2015, 2016 onward, it just went parabolic and it lasted for years.

16:17
And now it’s finally coming back down to that rising trend line. But, you know, if you were shorting it since 2016, you’d probably be down like 3 or 400% on that, right? So you can have me reversions to trend lines, that’s one way to play it. If you look at the price move off of the March 2020 highs when it tanked right after the whole economy shut down and then it popped right back up.

16:39
Even all of that, both the sell off and the bounce back was somewhat of a mean reversion. Now, following the bounce back, it just kept going back higher. So, but you had two mean reversions right in there. So mean reversions can take different forms. Is it better in a market sell-off?

16:56
Not necessarily. I mean, a lot of the trading patterns that you play to the long side can also be played to the short side. You just Reverse or flip upside down, the charting patterns, for instance, like head and shoulders patterns are the opposite of an inverse head and shoulders patterns. Inverse head and shoulders patterns work great in a bull market.

17:13
Head and shoulders patterns work great in a bear market. Same thing with cup and handle patterns or inverse cup and handle patterns, bull flags versus bear flags. Right now, I’m using a lot of inverse ETS and I’ve been doing really good on it this year. While the market’s been selling off, using just basic technical analysis like Bear flags, for instance, on IWM it’s had this massive bear flag going back about 3 months.

17:37
It confirmed that this past week I got short on IWM. But I think with any trading strategy, and one of the things that’s really helped me to become a successful trader in life is over the years making my trading strategy more and more unique to me and so I think while what I do is a very good trading strategy and a lot of people can duplicate it, I think it’s even better when people can take that like what I’m doing and the trading patterns that I trade off of and then make it unique to them as well to tweak it here and tweak it a little bit there, maybe make it more.

18:10
Applicable to that person’s lifestyle versus what it is to my lifestyle and just to continue to tweak that trading strategy so that it works for you to minimize the emotions to. Maximize your discipline to utilize risk management skills and to make you a better trader. And I’d be remiss if I didn’t mention the fact that I have swingtradingthestockmarket.com, which accommodates so many different trading approaches in the stock market by providing you with some of the most unique charts that you’ll see each and every day.

18:37
As well as my setups that I’m following each morning and my weekly watchlist for both Bullish and Bear stocks, and you’re going to get updates on all the Fang stocks and market indices. So check that out, swingtradingthestockmarket.com. Now, the takeaway on all of this, whether you’re trading breakouts, episodic pivots, mean reversions, whether you’re trading trending stocks or parabolic shorts.

19:00
What you want to do is always try to make the strategy unique to you, to your personality. Also, when it comes to like the episodic pivots, you want to remember that there’s a lot of emotion in those trades. I’m not a huge fan of them. Usually it requires you to have to take on a lot of volatility and a lot of people will blow out their accounts in the process because they don’t know how to manage that stuff.

19:19
It’s better to start with large cap stocks, swing trading because for the most part, I’m not saying this to be true all the time because I mean Tesla, for instance. Is a very large cap stock and look what it’s done. I mean, I think it was down like well over 10% today alone, 13% actually.

19:35
So, I mean, large caps can have their moments of incredible volatility, but when compared to like micro crop stocks, there’s a lot more stability in the large caps than there is in those. So if you have any questions, make sure to send it to me, ryan@shareplanner.com. I put almost every one of these on air.

19:52
So if you send me a question, there’s a very good chance that I will make a show out of it. And don’t forget to leave those 5 star reviews. Guys, those things really helped me out a lot, man. I know I, I say every episode, but if you’ve listened to every episode and you haven’t done it yet, come on, man, leave me with 5 star.

20:09
All right, guys, check out swingtradingthestockmarket.com. Thank you and God bless. Thanks for listening to my podcast, Swing Trading the stock market. I’d like to encourage you to join me in the SharePlanner trading block where I navigate the stock market each day with traders from around the world.

20:26
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20:48
If you have any questions, please feel free to email me at ryan@shareplanner.com. All the best to you and I look forward to trading with you soon.