The challenge in mean reversion strategies like pairs trading is to find opportunities with value that are about to mean revert. Often, relationships with significant statistical value have strong momentum in one direction. This is true in pairs trading, value investing, and many other relative value trading strategies.
The key in trading these relationships is finding the catalyst for a momentum change. In most market conditions, it is a futile exercise to trade pairs on the basis of statistical value only. One must also understand the dynamics that are in place to kill the momentum that has pushed the relationship into the area of statistical value.
Don't enter into a statistical trade unless you have strong conviction that a catalyst is evolving to kill the momentum. That is how we think about this at Bigger Capital.
What are your thoughts on this topic?
Written by Michael Bigger. Follow me on Twitter and StockTwits.