Illustrative article · Sample editorial content and publication date, prepared for this website. Not a disclosure of proprietary research.
A relationship, not a level
Mean reversion is usually found in relationships between instruments rather than in single prices. When two related instruments drift apart, the spread between them can be measured in standard deviations and tested for a tendency to return.
Testing the tendency
Stationarity tests, half-life estimates and out-of-sample checks each answer part of the question. A spread that reverts on average can still take longer to do so than a strategy can afford to wait.
When relationships break
Relationships reflect economic links that can change. Stops, position limits and regular re-estimation exist because the most expensive trade in a relative-value book is the one that assumes a broken relationship will recover.