Jump to content

Welcome to the new Traders Laboratory! Please bear with us as we finish the migration over the next few days. If you find any issues, want to leave feedback, get in touch with us, or offer suggestions please post to the Support forum here.

  • Welcome Guests

    Welcome. You are currently viewing the forum as a guest which does not give you access to all the great features at Traders Laboratory such as interacting with members, access to all forums, downloading attachments, and eligibility to win free giveaways. Registration is fast, simple and absolutely free. Create a FREE Traders Laboratory account here.

Do Or Die

Trend Following Vs Mean Reversion: Trading Regimes

Recommended Posts

Almost everyone acquainted with technical analysis knows that trend following indicators work great in trending markets while oscillators work great in range bound markets. What if we could predict accurately whether market will be range bound or trending tomorrow? Well, that would literally allow printing money by shifting from (say) MA crossovers and RSI signals. However, such holy grail does not exists. Mr. Market does not foretells, “Hey, I’m going to continue moving in this direction for next 3 weeks, so please carry your trade; Or I’m going to reverse trend tomorrow from such level so please book your profit and reverse your trade.”


Trading Regime analysis means trying to identify similar periods of low volatility or price range contraction; and rising to high volatility or price range expansion. Regime analysis is looking to identify periods when conditions will calm down, at least in the direction of the immediately preceding trend, then this is similar to other so-called mean reversion.

Market moves in phases of low volatility to high volatility. Phases of low volatility can be associated with prices stuck in a trading range, congestion area or a very slow trend. Similarly, phases of high volatility can be associated with clear, larger, and directional moves.


Volatility is a very generic term used in reference to trading so let me elaborate what I’m referring by ‘volatility’ here. To clarify, I’m not referring to volatility as end-of-day price returns; but as the price changes relevant to the time frame you are trading. For a swing trader, a stock which hardly moves by 5% at end-of-month will be less volatile than a stock which moves 15% in a month. For a daytrader, a stock which moves by 0.5% will be less volatile at end-of-day than a stock which moves by 4%.


I’m using ‘volatility’ in this article in reference to the expansion and contraction of price ranges for a particular time frame rather than the generic speed of change in the prices. Trading Regime refers to whether a market is in a trending mode, range-trading mode or whether it is doing a bit of both. My strategy focus is to identify when such trading regimes exist and when, more importantly, they are likely to change or switch. This can help choose the right trading or investment techniques that go with the particular trading regime and not try to persist with something that would obviously not produce good results in that regime.


Let us get started with an example. The Standard Deviation on price changes on a rolling window of last 20 days is a crude way to measure volatility.




The vertical lines on the chart indicate where the standard deviation has reached what could be thought of as historically low (hi) levels and we can see that the drop in the standard deviation to these low levels usually, not always but usually, precedes a strong trend like move in the price of the OIH. The calculation properties of the standard deviation simple support this observation. The standard deviation is calculating the distribution of price values over a specified time period and so if the standard deviation is low then it suggests that the distribution of price values has been occurring in a tight range. That is, the market has been range trading. Given the mean reverting (cyclical) nature of the standard deviation then, after a period of range trading, it is reasonable to expect the market to enter a period of higher standard deviation and that usually means a trending period. Sometimes, of course, the resulting price action is not a strong trend and the analyst has to be open to this possibility. However, the probability lies with the fact that after a period of price range contraction comes a period of price range expansion.


In addition to a low standard deviation preceding a trending move in the market, a high standard deviation can precede a range-trading move in the market.


Just as low volatility will probably be associated with a coiling price pattern such as a triangle and high volatility will probably be associated with a trend exhaustion turning phase perhaps with momentum divergence, candlestick reversals, volume considerations, gap theory and most other methodologies will all be cousins of each other. All these linkages are inevitable because we are, after all, analyzing the same underlying variable, the price; it is just that there are different ways of expressing the analysis.


Technical techniques in relation to volatility breakouts have become popular whereby most people tend to think of these analyses as useful only for short-term market movements. This, is unjustified because whatever time frame (or fractal) is being examined, the market is being driven by the same underlying psychology that comes from human emotions. Price patterns repeat themselves at every degree of the market. A time series chart of one-minute closing prices will look similar in certain circumstances to a chart showing one month closing prices because the underlying driver of the market is the same human psychology that causes price trends and reversals of those trends. Trading regime analysis, can be broadened out considerably to look at both the long time frames as well as intraday time frames.


As you must have already inferred from above discussion, for regime analysis we use components of market behavior which are cyclical in nature. The components could be any data related to price, volume, market internals or their derivatives.


Among market data, the most useful is Volume, Hi/Lo Index, TICK and TRIN indicators.


For price analysis, Elliott Wave can be particularly useful. Among price derivatives, the most useful are: Standard Deviation, ATR, Bollinger Band Width, Donchian Channels and ADX.


I will soon elaborate techniques (usual technical analysis indications) on indentifying regimes through some examples.





Share this post

Link to post
Share on other sites

Hi DoorDie....

as an old options trader and to help this thread or readers of it with a socially responsible message from the surgeon general :) ...not to hijack or attack it.


- the measures of volatility often bandied about in trading rooms have little to do with how volatility is measured and traded by those actually trading it. This is an often missued and abused term.


Both congestion and trends can have periods of both high and low volatility periods.

Often a better suggestion :2c: is to use/think in terms of - momentum, continuation, reversal - as we are often trading these things and their direction - not the volatility.


While you do attempt to define it and establish that volatility is often a generic term it is this statement as an example that can cause issue .....

"For a daytrader, a stock which moves by 0.5% will be less volatile at end-of-day than a stock which moves by 4%" - really?

I assume you mean the range of the stock was 0.5% or 4% for that day.


Within that day the 0.5% stock could have actually been less/more/just as volatile intraday, even if the range was smaller.

Just an alert for those when talking volatility.

Share this post

Link to post
Share on other sites



I very much appreciate your response, but I think there has been some misunderstanding here.


My short answer is "Context is king..."


I will like you to take note that volatility has a totally different perception for a stocks trader vs a options trader.


Say I'm a short-term stocks trader (holding one week to 2 months). I buy AOL in April around 19.00. It may have great daily range (ATR EOD (15)= 50 cent, 2.6% avg daily range) but its not moving around my buy price since last few months. I will be happy to dump it as low volatile.


Compare it with KO which has daily movement of around 1.4% BUT it has been moving in the time frame relevant to me. I will consider KO as more volatile than AOL as a short-term trader with history of past few months.




the measures of volatility often bandied about in trading rooms have little to do with how volatility is measured and traded by those actually trading it. This is an often missued and abused term.

Terms are misused when they are used out of context. Terms are abused when they are used in a totally irrelevant context.

I’m using ‘volatility’ in this article in reference to the expansion and contraction of price ranges for a particular time frame rather than the generic speed of change in the prices.


There is a lot to volatility itself and perhaps it deserves a separate article. BUT what I'm talking here about is Trading Regimes. Beginners say all the time that MAs do not work, RSI do not works and so on. The fact is every trading technique/indicator works in a suitable regime.


I will elaborate more on trading regimes soon.


Share this post

Link to post
Share on other sites

In addition to a low standard deviation preceding a trending move in the market, a high standard deviation can precede a trading range in the market.


As an aside, a high standard deviation can also precede a market reversal.





Share this post

Link to post
Share on other sites

been moving in the time frame relevant to me.


this is the important element in tracking volatility.


(sorry if there was any misunderstanding, I was not meaning to come across as provacative, more thought provoking as volatility is often misused and taken out of context and more often becomes part of the vernacular without such a discussion as this pointing out some crucial context elements)

Share this post

Link to post
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now

  • Topics

  • Posts

    • $DXCM (DXCM) DexCom stock top of range breakout watch above 75.61,

      analysis http://chart.st/DXCM
    • Date : 24th April 2018.

      MACRO EVENTS & NEWS OF 24th April 2018.

      FX News Today

      European Outlook: Asian markets moved mostly higher overnight, following on from a positive session on Wall Street and amid ongoing USD strength with a weaker Yen underpinning a 0.75% rise in the Nikkei. The Hang Seng is up 0.94%, the CSI 300 rallied 1.75% amid speculation that the government is considering easing some policies put in to limit the credit boom. The absence of any negative news on the trade front seems to have given stock markets some breathing space and U.S. futures are also up in tandem with U.K. futures. Oil prices are also up and the front end Nymex future is trading at USD 69.14 per barrel. For now though bonds are getting a boost and stock markets are also higher, with most European futures posting gains in tandem with U.S. futures and after a positive session in Asia. Today’s calendar focuses on confidence data out of France, Germany and the U.K.. The U.K. also has public finance data and Germany auctions 2-year Schatz notes.

      FX Update: The dollar posted fresh highs against the euro and yen, and many other currencies after a bout of demand in Asia, which extending a broad rally the greenback has been seeing against for over a week now. The narrow trade-weighted USD index (DXY) posted its highest level since the first week of January, at 91.07. EURUSD logged a 10-week low at 1.2184, though euro demand has subsequently fuelled a rebound to the 1.2220 area. USDJPY lifted for a sixth consecutive session, making a 10-week high at 108.87. EURJPY is also firmer, though has so far remained below the two-month high it saw last week. The gains in USDJPY have been concomitant with the U.S. T-note yield nearing the 3.0% level, which has been generating headlines, which comes with the BoJ continuing to peg JGB 10-year yields near 0.0%. The Nikkei 225 closed 0.86% for the better, more than reversing the moderate loss seen yesterday. North Korea’s Kim said that he would be willing to accept IAEA inspections of nuclear facilities.

      Charts of the Day

      Main Macro Events Today
        German IFO – The German Ifo business confidence indicator, due Tuesday, comes in a new format this month, which includes the services sector now. For the new indicator a dip is expected to 102.8 from 103.2, and a decline in the expectations reading to 99.5 from 100.1 in the previous month. However, after the better than expected PMI readings there is a bias to the upside to the numbers. In any case, we don’t expect the April round of survey indicators to really change the outlook for the ECB, which is seen on hold this week, with officials seeing scope to leave the final decision on the future of the QE program open until July, when the risks to the global outlook may have become a bit clearer and the decision is becoming urgent. UK Public Borrowing – Expectations – at 1.6B pounds from -0.272B pounds last month. US Consumer confidence – likely declined to 126.0 in April, from March’s 127.7. US New home sales – expected to rise to 0.630 mln in April from 0.618 mln in February. Support & Resistance Levels

      Always trade with strict risk management. Your capital is the single most important aspect of your trading business.

      Please note that times displayed based on local time zone and are from time of writing this report.

      Click HERE to access the full HotForex Economic calendar.

      Want to learn to trade and analyse the markets? Join our webinars and get analysis and trading ideas combined with better understanding on how markets work. Click HERE to register for FREE!

      Click HERE to READ more Market news. 

      Andria Pichidi
      Market Analyst

      Disclaimer: This material is provided as a general marketing communication for information purposes only and does not constitute an independent investment research. Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of buying or selling of any financial instrument. All information provided is gathered from reputable sources and any information containing an indication of past performance is not a guarantee or reliable indicator of future performance. Users acknowledge that any investment in FX and CFDs products is characterized by a certain degree of uncertainty and that any investment of this nature involves a high level of risk for which the users are solely responsible and liable. We assume no liability for any loss arising from any investment made based on the information provided in this communication. This communication must not be reproduced or further distributed without our prior written permission.
    • Addendum:
      Anar  Chicagoans, etc, etc, -  wake up !
      This -> https://www.mintpressnews.com/cheran-mexicos-indigenous-community-that-rebelled-against-narcos-thieves-and-politicians-and-won/240979/
      instead of this -> http://massprivatei.blogspot.com/2018/04/smart-city-projects-are-really-police.html
    • $WD (WD) Walker & Dunlop stock nice bull flag breakout watch,

      analysis http://chart.st/WD
    • $BOFI (BOFI) stock narrow range breakout watch above 42.54,

      analysis http://chart.st/BOFI

Important Information

By using this site, you agree to our Terms of Use.