Business & Finance

Comparing Trend Trading and Mean Reversion Trading

Two trading styles have become the talk of the town for quite some time, aside from Forex trading. The mean reversion trading and trend trading. Today, we are going to tackle these two styles and how each of them gives benefits to traders.

What is a Trending Market?

The trending market is where the market structure has higher lows and higher highs (or vice versa). It is also defined as using trend lines, although its effectiveness depends on the candlestick chart that you want to use.

Characteristics of a Trend Trading Strategy

  • The Holding Time is Longer – Usually, the holding time of trend trading is much longer. This is all because of the nature of the trend, as it builds an angle in one direction.
  • It has a high reward-risk ratio – most of the time, a trader can obtain multiple gains in every unit of risks that they have taken. If you think that the market is one-directional, you must capture the whole of the move while letting your wins run.
  • It has a Lower Winrate – since you will have larger average payoffs, the winrate in your every trade will also decrease. There is this inverse relationship of reward-risk as well as winrate, leaving trend followers of a 40% winrate.

What is Mean-Reverting Market?

It is defined as the area of the price consolidation, clearly defining the lower and upper boundaries. A range, most of the time, will look like a box and a rectangular shape will be drawn into it.

Characteristics of a Mean Reversion Trading Strategy

  • It has a shorter holding time – mean reversion has this ‘snap back’ nature prompting it to have a shorter hold time. Traders of mean reversion mainly like to have short-term corrections right into the mean.
  • It has a low reward-risk ratio – when prices step out of the line with the mean, they usually don’t offer too many ticks, contrary to trend trading.
  • It has a higher winrate – still contrary to trend trading, mean trading offers a higher winrate because of the inverse relationship of the reward-risk ratio. Trend traders usually have a 60% winrate.

Advantages of Trend Trading

Entering a trend at the very start means that you wouldn’t have to miss any kind of trend. You get in as the trend starts, resulting in a no-miss strategy. Another good thing about trend trading is that you get the majority of the trend since you came first. Your entries don’t have to be so precise since trend trading does not have to be in the perfect entry.

Advantages of Mean Reversion Trading

With mean reversion trading, there is actually more time to spend when it comes to ranging state, something that’s been considered as an advantage of mean trading. It also has a low hold time compared to trend trading. Since it has a lower hold time, it also gives you safety against internal shocks. Mean trading also offers smaller drawdown periods. This means that you can go for a longer winning streak. The reduced drawdowns will help you get through with the psychological effects because you can better predict the future, just like in Forex Trading.