Markets often exhibit tendencies that, for the astute trader, may translate into profits. One such tendency is what I refer to as the “rubber band effect.” The fact is that markets tend to overshoot, similar to a rubber band that’s stretched to its extreme and then has to snap back to its normal tension. This theory is based on the premise of “mean reversion” which is simply that when the price of any market deviates substantially away from its medium price (otherwise known as an “outlier”) the odds increase substantially that it will revert back to the average.
This hyper-extension of markets has to do with the herd mentally of market participants and is essentially what panic or euphoria look like on a price chart. This pattern is repeated quite often in the markets and is worthwhile in identifying, as it often times serves to uncover some very attractive risk/reward opportunities. Professional traders refer to these moves as the “extremes” because it’s these moves that pit the novice against the professional. The key to making this profitable is gauging how far is too far.
There are various indicators… Continue Reading
