Mean reversion trade ideas sometimes yield outsized returns. This type of trade has been around forever and still has a decent chance of success. Of course, this entirely depends on sound risk management practices. There is nothing worse than putting on a trade and losing money because you can’t admit you’re wrong.
At the moment, I’m cautious to put any trade on because we are on the cusp of a change in monetary policy. Big bank CEOs are screaming for the Central Banks to raise rates ASAP. Indeed, they’re completely biased and talking up their book as banks make a lot of money as interest rates rise.
There has been a lot of chatter that rate hikes will slam technology stocks and growth in general. I tend to agree, but only once rate hikes have moved enough or there is a policy error. The chances of a policy error cannot be ignored.
Over the past six weeks sellers have pounded growth stocks, especially technology, and this has offered up some interesting opportunities.
Two stocks are on my radar as possible mean reversion trades. That is Lululemon and Shopify. Both great companies with solid fundamentals.
Mean reversion is a scenario where a stocks price fluctuates above and below its long-term trend. These types of trades are rare and offer a decent chance of success. I define the long-term trend and the 200 day moving average. Typically, when price extends well beyond the trend, it snaps back to trend. A simple concept to understand.
Without further delay, below are two interesting mean reversion trade candidates.
Lululemon – mean reversion candidate #1
The chart below illustrates the extent of the decline. Yes, Lulu’s Mirror product is a disappointment, as it only accounts for ~3% of sales.
Shopify – mean reversion candidate #2
Again, the chart below looks very similar to Lulu’s decline. Shopify’s free cash flow growth is a sight to behold, but can it continue? I’m not sure, but I would not bet against ecommerce.
Conclusion
Mean reversion trade ideas sometimes yield outsized returns.
I’m holding off until next week to gauge the market’s reaction to the BoC decision (Jan 26th) and the outcome. I expect the BoC will get the ball rolling and raise rates. The Fed will likely follow in March as QE comes to an end.
More importantly, I want to see if a proper base can solidify in Shopify and Lululemon. For example, if Lulu can hold support at $323.50 the stop loss is easily placed just below $323. As for Shopify, the mythical $1,000 handle is within striking distance. Regardless, sticking to sound risk management processes are absolutely critical to this and all trades.
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