Mean reversion is the financial theory that asset prices and other financial variables such as valuations, volatility, or interest rates tend to return to their historical long-term average over time after deviating significantly in either direction. Traders who apply mean reversion strategies buy assets that have fallen well below their historical average and sell those that have risen far above it, betting that extreme deviations are temporary. In Indian equity markets, mean reversion strategies are applied across stock valuations (P/E reversion), sector rotations, and pair trading setups. Quantitative hedge funds and algorithmic strategies use statistical measures like z-scores and Bollinger Bands to systematically identify and trade mean reversion opportunities.
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