# Anatomy Of Mean Reversion in EasyLanguage

Look at this equity curve:

As long as you are in a bull market buying dips can be very consistent and profitable.  But you want to use some type of entry signal and trade management other than just buying a dip and selling a rally.  Here is the anatomy of a mean reversion trading algorithm that might introduce some code that you aren’t familiar.  Scroll through the code and I will  summarize below.

``inputs: mavlen(200),rsiLen(2),rsiBuyVal(20),rsiSellVal(80),holdPeriod(5),stopLoss\$(4500);vars: iCnt(0),dontCatchFallingKnife(false),meanRevBuy(false),meanRevSell(false),consecUpClose(2),consecDnClose(2);Condition1 = c > average(c,mavLen);Condition2 = rsi(c,rsiLen) < rsiBuyVal;Condition3 = rsi(c,rsiLen) > rsiSellVal;Value1 = 0;Value2 = 0;For iCnt = 0 to consecUpClose - 1 Begin	value1 = value1 + iff(c[iCnt] > c[iCnt+1],1,0);end;For iCnt = 0 to consecDnClose - 1 Begin	Value2 = value2 + iff(c[iCnt] < c[iCnt+1],1,0);end;dontCatchFallingKnife = absValue(C - c[1]) < avgTrueRange(10)*2.0;meanRevBuy = condition1 and condition2 and dontCatchFallingKnife;meanRevSell =  not(condition1) and condition3 and dontCatchFallingKnife;If meanRevBuy then buy this bar on close;If marketPosition = 1 and condition1 and value1 >= consecUpClose then sell("ConsecUpCls") this bar on close;If meanRevSell then sellShort this bar on close;If marketPosition = -1 and not(condition1) and value2 >= consecDnClose then buyToCover this bar close;setStopLoss(stopLoss\$);If barsSinceEntry = holdPeriod thenBegin	if marketPosition = 1 and not(meanRevBuy) then sell this bar on close;	if marketPosition =-1 and not(meanRevSell) then buytocover this bar on close;end;``
Mean Reversion System

I am using a very short term RSI indicator, a la Connors, to initiate long trades.  Basically when the 2 period RSI dips below 30 and the close is above the 200-day moving average I will buy only if I am not buying “a falling knife.”  In February several Mean Reversion algos kept buying as the market fell and eventually got stopped out with large losses.  Had they held on they probably would have been OK.  Here I don’t buy if the absolute price difference between today’s close and yesterday’s is greater than 2 X the ten day average true range.  Stay away from too much “VOL.”

Once a trade is put on I use the following logic to keep track of consecutive closing relationships:

``For iCnt = 0 to consecUpClose - 1 Begin	value1 = value1 + iff(c[iCnt] > c[iCnt+1],1,0);end;``
Using the IFF function in EasyLanguage

Here I am using the IFF function to compare today’s close with the prior day’s.  iCnt is a loop counter that goes from 0 to 1. IFF checks the comparison and if it’s true it returns the first value after the comparison and if false it returns the last value.  Here if I have two consecutive up closes value1 accumulates to 2.  If I am long and I have two up closes I get out.  With this template you can easily change this by modifying the input:  consecUpClose.  Trade management also includes a protective stop and a time based exit.  If six days transpire without two up closes then the system gets out – if the market can’t muster two positive closes, then its probably not going to go anywhere.  The thing with mean reversion, more so with other types of systems, is the use or non use of a protective stop.  Wide stops are really best, because you are betting on the market to revert.  Look at the discrepancy of results using different stop levels on this system:

Here an \$1,800 stop only cut the max draw down by \$1,575.  But it came at a cost of \$17K in profit.  Stops, in the case of Mean Reversion, are really used for the comfort of the trader.

This code has the major components necessary to create a complete trading system.  Play around with the code and see if you can come up with a better entry mechanism.

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