Discussing the article: "Formulating Dynamic Multi-Pair EA (Part 3): Mean Reversion and Momentum Strategies"
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Check out the new article: Formulating Dynamic Multi-Pair EA (Part 3): Mean Reversion and Momentum Strategies.
In this article, we will explore the third part of our journey in formulating a Dynamic Multi-Pair Expert Advisor (EA), focusing specifically on integrating Mean Reversion and Momentum trading strategies. We will break down how to detect and act on price deviations from the mean (Z-score), and how to measure momentum across multiple forex pairs to determine trade direction.
Mean reversion is a trading concept based on the idea that prices, over time, tend to return to their average or "mean" value. This theory assumes that extreme movements in price, whether upward or downward, are temporary and will eventually correct toward a historical norm. In financial markets, these extremes are often caused by short-term imbalances in supply and demand, overreactions to news, or liquidity shocks. Mean reversion strategies aim to capitalize on these temporary price dislocations by identifying when an asset is statistically overbought or oversold, and then entering trades in the opposite direction with the expectation that price will revert to its mean.
Under the hood, mean reversion is typically implemented using statistical tools such as the Z-score, which measures how far the current price deviates from a moving average in terms of standard deviations. A high positive Z-score suggests the price is far above its average (potentially overbought), while a low negative Z-score suggests it is far below (potentially oversold). Traders set thresholds (e.g., +-2.0) to determine when a deviation is significant enough to warrant a trade. Once the threshold is breached and additional conditions (like weakening momentum or a reversal signal) are met, a trade is opened anticipating price reverting to the mean. This strategy is most effective in ranging or mean-reverting markets and requires careful risk management, as persistent trends can invalidate reversion signals if not accounted for.
Author: Hlomohang John Borotho