Polynomial Regression Bands (PRBs) have been around for quite some time, although I know of very few traders who use them seriously. I happen to be a strong advocate of mean reversion and PRBs are my main tool for determining when and how price action returns to mean. There are many other bands in the trade; Bollinger bands and the Keltner channel come to mind. But for my purposes, I customized the traditional PRB into something that fits my needs perfectly. Of course, the process of refining the variables to use with the bands was a long process that took several years until I felt comfortable with the product that I now use every day.

For anyone who has taken a statistics class, you will know that a standard deviation (SD) is a measure of error. You’ll often see presidential polls indicate the percentage of voters favoring each candidate, and if you read the fine print at the bottom of the page, they’ll indicate the accuracy of the poll is + or -3%. This means that the survey could be wrong by 3% on the high side and 3% wrong on the low side. So far the theory of polls.

Traders often over-buy or over-sell a security at any given time during the day. When price becomes too overbought or oversold, it usually hits the inside band, which is 2 SD from the midline, and things start to turn around. On certain occasions, the price action could well go as high as 3SD. When the price gets so far out of line, another group of traders springs into action. These traders are called arbitrage traders and they profit by trading the security against a related security. The result is usually a return to the midline for the overbought or oversold stock; hence the term mean reversion. This trading behavior is especially prevalent in the ES contract where there is literally an army of arbitrage traders.

Now you can see that the mean trading reversion is the result of several trading processes. Polynomial regression bands are my attempt to quantify this complicated chain of events and quantify when price will move towards the mean. It is a very precise trading method. I record every trade I make and indicate the type of input I used to enter the trade. Mean reversion trades have a 79% chance of moving 6 or more ticks in profit, usually much more. However, this style of commerce is often overlooked in the retail ecosphere. I have no idea why.