Gold Mean Reversion

Trend following trades WITH momentum (buy strength, sell weakness). Mean reversion trades AGAINST extremes (sell overbought, buy oversold). Trend following catches big moves; mean reversion profits from oscillations. Different market conditions favor each approach.

Trend continuation - The price keeps moving against you instead of reverting. You're essentially betting the trend will end, but sometimes it doesn't. That's why regime filtering (ADX < 20) and strict stops are critical.

Check ADX indicator. ADX < 20 = Ranging (good for mean reversion). ADX > 25 = Trending (avoid mean reversion). Also look at Bollinger Band width - Narrow bands suggest ranging. Visual inspection of price action helps too.

For day trading: 15-minute or 1-hour charts with VWAP. For swing trading: Daily charts with 20 SMA and Bollinger Bands. The key is matching your mean calculation to your holding period.

Mean reversion should happen relatively quickly. Intraday trades: 2-4 hours. Swing trades: 2-5 days. If not reverting in this time, the thesis may be wrong. Use time stops.

Best combination: RSI extreme (>70 or <30) + Bollinger Band touch + Reversal candle. Add divergence for even higher probability. The more indicators confirming the extreme, the better. Score your setups: 3+ confirmations = Good trade.

VWAP is calculated from the start of the trading day. Each new day resets the calculation. This makes it an intraday reference. For multi-day trades, use anchored VWAP or moving averages instead.

Band walk occurs when price stays at or beyond the Bollinger Band for multiple candles. This indicates strong trending momentum. Fading a band walk is dangerous because the trend may continue. Wait for the walk to end before mean reversion.

Use smaller size (0.5-1% risk) compared to trend following (1-2%). Counter-trend trading has higher failure rate. Smaller size protects capital if the trend continues. You can scale in if price goes further against you.

Divergence isn't guaranteed. It fails when: The trend is very strong (ADX > 30). There's a fundamental catalyst driving price. The divergence is on very short timeframe (noise). Always use stops regardless of divergence.

Steps: 1) Define mean (rolling SMA, EWMA). 2) Calculate Z-Score: (Price - Mean) / StdDev. 3) Entry when Z > +2 (short) or Z < -2 (long). 4) Target Z = 0. 5) Backtest 10+ years. 6) Walk-forward validate. 7) Adjust for gold-specific half-life (3-10 days).

OU process models mean-reverting prices mathematically: dP = θ(μ - P)dt + σdW. θ = Speed of reversion. μ = Long-term mean. σ = Volatility. This provides theoretical framework for estimating reversion speed and optimal position sizing.

Long put at overbought (RSI > 70, upper BB): Defined risk, profit from decline. Long call at oversold (RSI < 30, lower BB): Defined risk, profit from bounce. Use near-term expiration (7-21 days) since mean reversion should be quick. Vertical spreads reduce cost.

Key metrics: Win rate (should be 55-65%), Avg Win/Avg Loss ratio, Profit factor (>1.3 target), Max drawdown (<15% target), Sharpe ratio (>0.8 target), % of winning months. Also track by regime (ranging vs trending) to validate regime filter effectiveness.

Monitor ADX direction. ADX < 20 but rising = Regime may be changing. Reduce size as ADX approaches 22-25. Stop new entries if ADX crosses 25. Manage existing positions tighter. Resume mean reversion when ADX declines below 20 again.