Mean Reversion Swing Trading in Copper Futures

Copper, often referred to as "Dr. Copper" for its supposed ability to predict turning points in the global economy, is a cyclical commodity that exhibits strong mean-reverting tendencies. This means that after a period of strong trending price action, copper prices have a high probability of returning to their long-term average. This article will detail a contrarian swing trading strategy for copper futures (/HG) that is designed to capitalize on these mean-reverting characteristics. The holding period for these trades is typically 3 to 10 trading days.

Understanding the Mean Reversion Edge

The edge in a mean reversion strategy comes from the fact that markets, especially commodity markets, tend to overreact to news and events. This overreaction can push the price of copper significantly above or below its fundamental value. A mean reversion trader seeks to identify these extreme price levels and take a position in the opposite direction of the prevailing trend, with the expectation that the price will revert to its mean.

Entry Rules

Our entry is based on a combination of an overbought/oversold indicator and a price action confirmation.

• Overbought/Oversold Indicator: We use the 2-period RSI to identify overbought and oversold conditions. A reading above 95 is considered overbought and a potential sell signal. A reading below 5 is considered oversold and a potential buy signal.
• Price Action Confirmation: For a sell signal, we are looking for the 2-period RSI to cross back below 95. For a buy signal, we are looking for the 2-period RSI to cross back above 5.
• Entry Trigger: We enter a short position on the open of the next candle after the RSI crosses back below 95. We enter a long position on the open of the next candle after the RSI crosses back above 5.

Exit Rules

We use a fixed profit target and a time-based stop to exit the trade.

• Profit Target: The profit target is the 20-period simple moving average. The idea is to capture the move back to the mean.
• Time-Based Stop: If the trade has not reached its profit target within 5 trading days, the position is closed.

Stop Loss Placement

• Initial Stop Loss: For a short trade, the stop loss is placed above the high of the entry day. For a long trade, the stop loss is placed below the low of the entry day.

Position Sizing

• Risk per Trade: Risk no more than 1% of your trading capital on any single trade.

Risk Management

• Trend Identification: This is a counter-trend strategy, so it is important to be aware of the direction of the longer-term trend. The strategy will be more successful in a range-bound market than in a strongly trending market.
• Economic Data: Be aware of major economic data releases that could impact the price of copper, such as GDP growth and manufacturing data from China.

Trade Management

• No Trailing Stop: We do not use a trailing stop for this strategy. The goal is to capture the move back to the mean, and a trailing stop may take us out of the trade too early.

Psychology

• Fading the Crowd: This is a contrarian strategy, which means you will often be buying when everyone else is selling and selling when everyone else is buying. This can be psychologically challenging, but it is the source of the edge.