Blog, Strategies

Market Pulse: Market Filter on Equilibrium Oscillation

Posted by Erik Martin Hansén

On Fridays, Market Pulse focuses on rule-based strategies. We use systematic models based on data, objective signals and risk diversification.

Today we'll continue our spin on market filters and look at a weekly strategy based on equilibrium swings.

Mean reversion is based on a simple idea. Stocks tend to return to their mean value after large movements. If a stock has fallen a lot in a short period of time, there is often an excess of selling pressure that has created a temporary mispricing. When that pressure eases, the stock bounces back and that is the movement we want to capture.

But here's the catch. Buying stocks that are falling works great in a rising market. In a bear market, however, a stock that looks cheap can become even cheaper and then even cheaper. There is no floor when the entire market is selling off.

So the question we are testing today is: how can we adjust the rules to avoid the worst periods? Should we stop buying altogether when the market turns down, or is there a smarter way to reduce risk without missing out on too much of the upside?

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Posted by Erik Martin Hansén
After studying at Uppsala University, Erik Hansén has worked in the financial industry since 2007 at several brokerage firms and traded privately. In his role as an analyst, Erik has written highly regarded market letters.

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