Mean Reversion vs Momentum Forex Strategies Guide

2025.11.13 2025.11.13
Mean Reversion vs Momentum Strategies in Forex: Which Trading Strategy Works Best

Oleg Tkachenkohttps://www.litefinance.org/blog/authors/oleg-tkachenko/

Mean reversion and momentum trading are two strategies designed for different trading styles. Momentum trading assumes that a market impulse, when confirmed by fundamental factors and volume, will persist for a long time. Mean reversion, on the other hand, assumes that momentum is short-lived and that prices will return to a balance between supply and demand. Momentum trading is a trend-following strategy, while mean reversion is a short- and medium-term trading strategy, often used in scalping and swing trading.

This review will introduce you to both types of trading and explain how indicators work for each strategy. These useful tips will help you develop your own trading system.

Major Takeaways

• Momentum trading on Forex involves opening trades in trending markets, triggered by fundamental factors, market optimism, or large capital inflows.
• Mean reversion strategies suggest that momentum runs out of steam quickly and that prices always return to their average value.
• Momentum trading is believed to be more profitable due to strong long-term trends. However, trading signals appear less frequently. Mean reversion trading is a short-term trading technique with frequent signals but minor price movements.
• Momentum trading is effective when a strong trend is confirmed by a fundamental backdrop.
• The mean reversion strategy is effective during periods of high market volatility.
• Trend indicators, trend strength indicators, and volume indicators are suitable for momentum trading strategies.
• Channel indicators, oscillators, reversal patterns, pivot points, resistance, and support levels are applicable to a mean reversion trading strategy.

What Is Mean Reversion in Trading?

What is mean reversion in trading? Reversion trading is a statistical and trading concept based on the assumption that the price of an asset tends to revert to its mean after deviating from it. If the price has moved significantly up or down relative to its mean over a given period, it will tend to return to that mean.

The core underlying principle is that traders overvalue or undervalue assets based on emotions, news, or other short-term factors. After such extreme movements, the price stabilizes and returns to its average level.

For example:

• MicroStrategy is ramping up its investment in BTC. The news is definitely positive, with the BTC/USD pair surging sharply by 5% overnight. Short-term traders immediately lock in profits on their long positions, and the price rebounds, sliding to the downside.

• Without any significant factors, the BTC price sags by 5%. Positive news is expected in the future, so it’s time to open buy trades at the lowest price. Growing demand pushes the price higher to the average value.

Some studies explain the principle of mean reversion through probability theory, which considers three fundamental rules:

• The true price represents market equilibrium. It is the price at which supply and demand are in balance.

• The current price often does not reflect an asset’s true value.

• The difference between the true and current prices can be explained by fundamental or behavioral factors.

Depending on market conditions, the supply/demand balance point may be at different levels. For example, during a recession, there will be fewer buyers, and the balance point will be lower. When a growth phase begins, the supply/demand balance shifts upward. However, the true price will be higher than the balance due, as buyers seek to profit from the upward trend. At some point, the market becomes overheated (overbought), and the price reverts to its equilibrium value.

Factors on which the mean reversion theory is based:

• Behavioral factors. Traders’ emotions — primarily fear and greed — drive short-term fluctuations, but the market does not remain unstable for long.

• Artificial liquidity. Major players use extreme price movements to open opposite positions.

• Limited trend. Even strong impulses eventually run out of steam and turn into corrections or reversals.

• Statistical regularity. Any value with a normal distribution will eventually approach its mean.

The mean value does not necessarily lie on a horizontal line, indicating a sideways trend. It can also be an upward trend. For example, the average annual return on the S&P 500 stock index over the past 25 years has been 10-12%. However, there have been fluctuations in certain years: in 2021, it rose by 29.16%, and in 2022, it fell by 20.84%.

The line is drawn from October 2018 to October 2025 based on a return of about 16% per year. This means that, ultimately, any strong momentum deviation was followed by a return to the mean—the momentum gain of one year was offset by the loss of the following year.

Core Principles of Mean Reversion Strategies

Here are several hands-on examples of how to use indicators and oscillators in a mean reversion strategy.

Example 1: The RSI returns to the mean. Currency pair – EUR/USD.

The oscillator shows overbought/oversold zones. If the Relative Strength Index (RSI) line exits the middle range, the market is overvalued or undervalued, and a reversal to the middle value is likely.

The red horizontal line is the approximate average value from which the price rebounds upward/downward and returns to the previous levels. At the lowest point of the price range, the RSI is in the oversold zone (1), and at the highest point, it is in the overbought zone (2). These are trading signals of a potential return to the mean. This pattern can be easily spotted on higher time frames starting from H1.

Example 2: Bollinger Bands Strategy. Currency pair – EUR/USD.

A channel indicator that widens as market volatility increases and narrows as the flat period approaches. The center line is a moving average, and the channel boundaries are based on standard deviation. The wider the channel, the more likely it is to narrow.

 The Forex strategy is as follows: wait until the channel expands as much as possible relative to previous periods and open a trade when it begins to narrow. 50% of the position should be closed in the middle of the channel, and another 50% at its boundary.

A narrow channel suggests a flat market. The price rises gradually, and strong momentum (a green candle with a large body) pushes it away from the moving average. The Bollinger Bands widen, but the price reverses. On the second red candle (1), you can open a short position. When closing the trade at the channel’s middle line, the profit is about 25 points.

Example 3: MACD momentum indicator + MA. Currency pair – EUR/USD.

The combination of an oscillator with trend moving averages can be used in both mean reversion strategies and momentum trading on Forex. The principle is as follows:

• The MA is the arithmetic average of the price over a certain period. It is better to choose long periods, for example, 50. The further the price deviates from it, the greater the likelihood of a reversion.

• When the moving average convergence/divergence (MACD) line crosses the signal line from above, a short position can be opened. Otherwise, a buy trade can be formed.

The chart shows a strong deviation of the price from the moving average to the upside, followed by a return to the mean. The purple MACD line crosses the yellow signal line, giving a signal to open a short position on the candlestick (1). The trade is closed when the price touches the moving average.

For long positions, the setup is similar. Although in both cases the MACD momentum signal is delayed, on the H4 time frame, the price has moved about 50% towards the moving average, bringing 35-40 points without taking a swap into account.

The examples given are not a strategy; they represent only examples of how to use a single indicator. Only a combination of several technical indicators with different types of mean reversion signals can be assembled into a complete trading system.

How Mean Reversion Works in Forex Markets

The concept of mean reversion trading seems entirely logical. It is necessary to wait for the end of a strong impulse and open a trade at a reversal point. However, this trading strategy has drawbacks:

• The mean is not fixed; it can shift when fundamental factors change. During a reversal, the price may not reach the level that you considered to be the mean. In other words, the price may not touch the expected take-profit level.

Example:

In the channel, the price at point 1 bounces upward from the average value on the impulse. At point 2, the upward momentum ends and a reversal begins. A short position can be opened here, but the price will unlikely trigger a take-profit order set at level 1. The balance of supply and demand has shifted to level 3, from which the price began to rise again.

• False trading signals. The end of the impulse and the price reversal may turn out to be a short-lived correction, after which the primary trend continues.

• “The market can remain irrational longer than you can remain solvent” (John Keynes). Sometimes, price movement can become counterintuitive to what seems logical. Remember that any trading strategy that seems to work can become ineffective at some point.

Some say that the profitability of the mean reversion strategy is lower than that of momentum trading. The reasoning is that price deviations from their mean are short-lived, whereas momentum implies a strong trend.

This is a controversial matter, as the price is trending about 30% of the time. The rest of the time, there is either a flat or volatile movement in both directions. Returning to the mean is similar to scalping or intraday trading, in which you need to capture short-term price movements. Scalping can be more profitable than trend trading because it involves more trades.

Understanding Momentum Trading Strategies 

Momentum trading in Forex can be referred to the following market setups:

• Trading on short-term momentum when market volatility increases, gaining profits on short-term waves.

• Trading on long-term momentum. This option will be discussed in the following sections.

Momentum trading is based on the idea of trend continuation. If the price is moving in one direction, this movement is likely to continue. In addition, market psychology also plays a key role. Traders flock to assets with strong trends and open trades in line with the primary trend. As a result, they generate additional demand and reinforce market momentum.

Impulse movement is based on the following:

• Fundamental factors. Strong financial reports of companies, economic data, and news.

• Psychological factors. Crowd behavior, fear of missing out (FOMO), market swings driven by the media, and the idea among traders that a trend is about to start in the market, etc.

• Technical signals. Breakthrough of key levels, growth in volume, acceleration of the trend. Traders perceive indicator signals as a “call to action”: the price has broken through a key level, so it’s time to open a trade. The more traders open positions in the direction of the breakthrough, the stronger the momentum.

• Actions of large investors.

On the chart, momentum is represented by accelerated directional price movement and growth in trading volume. Short-term deviations in quotes may be observed during the primary trend, with a return to the average level.

Example:

After a downward trend, an upward momentum began (red line). A trade opened at the beginning of the trend is momentum trading. Along the red line, you can see a wave pattern: the price moves up and down from the red line but then returns to it—this is a mean reversion. However, every trend ends eventually, and the next decline turned out to be a new momentum.

Notably, a trend impulse should be confirmed. If there is no clear confirmation, the trend quickly loses strength and the price returns to the average value.

Another option for impulse trading is the Turtle strategy, a momentum-driven approach that emphasises position sizing, entry and exit rules, and risk management.

Volume Spread Analysis (VSA) Strategy Targeting Trend Reversal Against Momentum

VSA (Volume Spread Analysis) is a market analysis method based on the correlation between trading volume and candlestick ranges. It can be used to interpret the actions of major players by analyzing patterns that emerge during periods of high/low volume and volatility shifts.

Here is a simple analogy. Imagine that you bake bread, for which you need to buy 1,000 kg of wheat every day. There are several dozen sellers in the market who are ready to meet the total demand at an average price of $6-8 per kilo. There is a balance of supply and demand in the market — on the chart, this is shown by a candle with a small body, as the price spread is insignificant.

Let’s say it’s currently off-season:

• You need 1,000 kg of wheat, but the market supply is limited to 200 kg. Sellers can increase the price at their discretion. The chart will show a candle with a large body and low volume because the market lacks the required supply.

• Sellers have 1,000 kg of wheat, but they believe they can get more than $8/kg for it. On the chart, this will look like a candle with a large body and a small volume.

The general principle of the VSA strategy is that if candlestick bodies are rising without increasing volume, then no one is supporting the movement. The momentum lacks strength, and the price is likely to revert to the mean. If the price and candlestick size increases are confirmed by an uptick in trading volume, the market is saturated with money, and the momentum is likely to continue.

Trading recommendations for the VSA strategy (technical analysis + trading volume):

Example 1:

Small candle bodies with low volume mean that both bulls and bears are inactive, and the market is flat. A large green candle with increased volume is a sign of a strong upward momentum. High volume with small candle bodies means balance and uncertainty. A decline in volume, alongside a decrease in candle bodies, signals the end of momentum and a transition to a flat market, with a possible return to the mean.

Example 2:

A downward trend with low volumes may signal a lack of buyer appetite, but the momentum’s strength is not confirmed. An upward trend change with no change in volume indicates a short-lived correction – the price lacks support and may revert to the mean, which could be confirmed by a large downward candlestick with high trading volume.

When It Is Profitable to Use Momentum Trading Strategy

Here are possible scenarios:

• When key news is released. Traders’ reactions fuel strong price momentum. The publication dates can be found in the economic calendar. However, there are also “black swans” that can dramatically change the trend in a matter of hours.

• During the trend acceleration phase (psychological effect). A trend has formed in the market, supported by fundamental factors. As soon as the price breaks through a key level, those who were waiting for confirmation of the signal enter the market. At the same time, trading volume increases.

• In financial markets with high liquidity and volatility. Momentum works when large participants create movement—institutional investors and hedge funds. Price movements of Apple or Bitcoin can drive the entire market.

• At times of great optimism, the Fear and Greed indicator exceeds 55. A figure above 70 may indicate market overheating.

Risks of the momentum strategy:

• Errors in assessing momentum strength. An expected strong momentum can reverse at any moment.

• Errors in choosing an entry point. Emotions (fear/greed) can lead to late entry, at the moment when the momentum ends.

• Risk of fundamental factors.

For example, during the first 10 days of October 2025, the cryptocurrency market experienced strong upward momentum, with BTC reaching new all-time highs and surpassing $123,000.

On October 10, 2025, Donald Trump announced the introduction of a 100% tariff on imports from China, effective November 1. The news instantly hit the market, and long positions worth more than $20 billion were liquidated, comparable to those following the bankruptcies of Terra Luna and FTX.

At the end of September, at the beginning of the upward trend, trading volume was almost $100 billion, and at the peak of the uptrend, it reached $200 billion. One piece of news was enough to reverse the trend to the downside. The Fear and Greed index fell sharply into the critical zone, and trading volume rose to $516 billion amid panic. As a result, the crypto market collapsed within hours.

This example shows that a trend momentum can end at any moment.

Essential Technical Indicators Mean Reversion and Momentum

As a rule, mean reversion traders use channel indicators based on standard deviation from the moving average or similar tools. These indicators provide insights into potential price reversals and overbought/oversold market conditions. Reversal patterns and key resistance and support levels are also likely to perform well.

Momentum trading indicators will signal an onset of strong movement. These indicators include trend indicators, volume indicators, and trend continuation patterns.

Best Mean Reversion Indicators

Every indicator has its advantages and disadvantages. The key issue is determining the optimal parameters, including the specific settings and combinations that will yield the best results.

There are several indicators for entry and exit signals:

• Channel indicators. Strategy: channel boundaries represent maximum price deviation from the channel midpoint. The channel’s middle line is the mean value. Among the best channel indicators are Bollinger Bands, Keltner Channel, and Donchian Channel.

• Oscillators indicate market overbought/oversold conditions, i.e., a potential price reversal to the “golden mean.”

• Reversal patterns such as Hammer, Shooting Star, Bullish and Bearish Engulfing, Doji, Pin Bar, etc.

• Pivot points reveal potential price reversal levels. The more distant the level the price breaks through, the higher the probability of a reversal.

• Resistance and support levels usually cause the price to reverse in the absence of a strong trend.

These indicators can be combined effectively. For example, a channel indicator can be a primary one, and an oscillator with reversal patterns can be used for signal confirmation.

Top Momentum Trading Indicators

The following indicators can be used for entry and exit signals:

• Forex momentum indicators – momentum and trend strength. For example, Momentum and ADX allow you to assess the strength of the current movement relative to previous periods.

• Moving averages – a standard basic tool that helps identify strong short-term impulses based on their position relative to the price and incline angle.

• Volume indicators allow you to track current changes in liquidity, detect abnormal spikes in trading volume, etc. In the stock market, an order book can be useful for seeing the levels of accumulation of pending orders.

Some oscillators can be used simultaneously for both types of trading. For example, in oversold/overbought zones, the RSI signals a return to the mean. An exit from the corresponding zones can be regarded as an impulse trend movement.

Conclusion

The momentum strategy involves trading on strong long-term trends, while the mean reversion strategy involves short-term trading on price rebounds from their mean.

These strategies reflect two different approaches to analyzing price performance, both of which are quite effective. A trend can change to a flat at any moment, and during a trend movement, the price can temporarily deviate from the average value and then return to it. Therefore, both strategies can be combined.

If you want to find out which approach suits you best, open a risk-free demo account with LiteFinance and try trading any asset.

We wish you successful trading!