But even more important high volatility often fuels mean reversion in equities which means that large down days are followed by large up days just as we are observing over the past two trading sessions. In low volatility markets momentum dominates and everything in between has less structure. Mean reversion is structurally driven by volatility and provides investors with an opportunity to become more tactically. In fact we would argue that as volatility increases investors should be less long-term and more short-term. By applying mean reversion tactics investors can add a vital return stream to the portfolio. But how should mean reversion be implemented?
There are several ways. The simple one is to short the stocks that did the best yesterday and buy the stocks that did the worst. As some sectors often lead the gains and declines one should consider not shorting and buying from the same sector. Another way to structure mean reversion is using technical indicators such as Bollinger Bands and RSI selling and buying when these indicators have high and low values respectively. The idea in mean reversion strategies to keep the volatility low is to both buy and sell which is best done on Saxo’s trading platforms through CFDs.