Evaluating four swing detection rules for mean reversion

A swing is two legs around a pivot

A price swing can be described as two opposing moves around a midpoint pivot. That pivot is the intermediate high or low that separates the two legs, and large participants may treat it as an entry or exit level.

In this archive a swing is a short-horizon price move. The work asked how to name the turning point, then how to test that name inside one mean-reversion procedure.

Four rules for naming the turning point

Four swing detectors were specified: a pivot high and low rule, a Bollinger Bands cross, a relative strength index threshold cross, and a relative strength index reading combined with a higher low or lower high.

A pivot low was defined when the prior bar’s low sits below both the two-bars-back low and the current low, marking an upswing. A pivot high used the symmetric high condition to mark a downswing.

Bollinger Bands are a moving-average envelope whose outer bands supply swing signals when price crosses them. Under that detector, an upswing was signaled when the close crossed above the lower 12-bar, two-deviation band, and a downswing when the close crossed below the upper band.

The relative strength index is a bounded oscillator of recent closes used with oversold and overbought thresholds, alone or with a higher-low or lower-high filter. Under the threshold-cross detector, an upswing was signaled when a 5-bar relative strength index crossed above 40, and a downswing when that reading crossed below 60.

The combined detector required a 5-bar relative strength index below 40 plus a higher low for an upswing, and a 5-bar relative strength index above 60 plus a lower high for a downswing.

One mean-reversion procedure

Each detector was run as a long-or-short mean-reversion procedure. Mean reversion, in this archive, enters against a just-detected swing and exits after a fixed holding period, with no new entry while a position is already open.

The shared steps were the same for every detector: enter on the next open after the swing signal, size a fixed notional by the close, and exit after four weekly bars. The holding period is that fixed number of bars. Only the rule that named the turning point changed.

Compare detectors through historical volatility

The evaluation used weekly bars on nine US sector exchange-traded funds over a 20-year window. Each detector’s outcomes were related to historical volatility, measured as average true range divided by the average of the last 120 monthly bars.

Historical volatility, in this archive, is average true range scaled by a long lookback of monthly average price. It was used to compare detectors across instruments, not to declare a single winner.