Glossary term
Mean Reversion
The tendency of prices to return toward a historical average; the foundation of cointegration and pair-trade strategies, opposite to momentum.
Mean Reversion is the tendency of a price or a spread to return toward its historical average after stretching away from it. It is the foundation of pair trades and cointegration strategies, which bet that a stretched relationship between two instruments will snap back. It is the conceptual opposite of momentum.
It matters because reversion is only tradable when the relationship is genuinely stationary. The danger is mislabelling a trend as a deviation: a spread that looks stretched can keep widening if the two instruments have structurally decoupled, turning a reversion bet into a compounding loss. Telling the two regimes apart is the whole game.
Closelooknet uses the Hurst Exponent to judge which regime an instrument or spread is in: a reading below 0.5 favours mean reversion, above 0.5 favours momentum. The Cointegration Monitor in the Lab tracks which pairs remain statistically linked and flags when a relationship breaks.
In practice, when the spread between two cointegrated names widens to roughly two standard deviations from its mean, a reversion view expects the gap to narrow; the same setup becomes a loss if the cointegration test stops holding and the spread keeps running.