Fashions in trading come and go, and many traders are shaped by their biggest wins and losses. This may explain why share market traders tend towards bearishness. Stocks go up by the stairs, and down in the elevator, meaning share traders often get their largest and fastest wins in falling markets. These happy experiences bias them towards negative views of the market.
Similarly, many forex traders prefer trending markets – these have delivered their best trades. Among technical traders, this often sees them leaning towards momentum indicators over mean reverting indicators In fact, some traders sometimes complain about sideways markets. What this usually means is that their momentum based indicators are not delivering useful signals.
However, picking the right mean reverting indicator for a sideways market can be both powerful and profitable. At the moment, the Bank of Japan appears to be on hold ahead of regional elections in April, temporarily halting the longer term Yen decline. The AUD is also treading water, after significant falls, ahead of the May federal budget. AUD/JPY is in a sideways range:
Bollinger bands are a classic mean reverting indicator. The chart above shows four profitable signals (green arrows) in the last eleven trading days – remembering that the signal occurs when the price moves back inside the band after first moving outside it. Traders then look for a return to the average – the middle line on the chart.
Each of these recent moves has delivered around 100 pips. Alert traders may look for further moves outside the bands, placing a trade to buy on a re-entry through the bottom band or a sell on a re-entry through the top band. Stop loss levels will depend on individual trading plans, but a 100 pip target would make a stop loss level of between 25 and 40 pips attractive to most.
The beauty of this approach is that it may be repeated, until eventually a new trend forms. The first stop out could be a sign of a new trend, and a significant widening of the bands (signalling a surge in volatility) would also invite caution.