The State of Short-Term Mean-Reversion: September, 2009
This is our monthly health check of short-term mean-reversion in the US market.
Why a health check? Because short-term MR (by “short-term”, think for example RSI(2)) is so important to what we index swing-traders are doing right now because at this moment in history, it’s the most effective directional trade.
See the July and August reports for details re: how this report is calculated. In a nutshell, we’re using both daily mean-reversion (the likelihood that down days follow up days, and vice-versa) and RSI(2) as simple proxies for all other short-term strategies. I would never recommend anyone actually trade either as I’ve defined them here, but I think they make a good proxy because this tendency for the market to retrace very recent gains is exactly why all of these short-term indicators work the way they do.
What is the state of short-term mean-reversion?
Very much under the weather.
3-month averages for the two metrics I think best capture short-term MR, “Return vs Vol” and “RSI(2) Stretch” (upper right and lower right graphs), are hovering near their lowest levels since short-term mean-reversion became the play du jour around the turn of the century. Both metrics have reached much lower points in individual months, but have rarely failed this consistently for this long.
Back in the real-world, I’ve seen a number of alt.-investment programs, that I know are trading short-term MR in some form, go off the rails the last few months. We’ve been fortunate that, despite leaning heavily on short-term MR in our own programs, our combined performance has been more or less flat.
Do I think short-term MR will stage a comeback? Yes. I think the breakdown over the last few months is tied to the strong protracted rally, but that this slow grind up will come to an end and that short-term MR will again be the play du jour once we get to the other side. Do I know that with any certainty? Absolutely not.
More to follow.
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