Mean reversion after extreme short-term moves

[Shadow Trader]

After a sudden spike of 15 pips in a minute, price often retraces some of it. It's one of the most commonly cited tendencies in intraday trading, and a favourite basis for scalping strategies.

The logic is sound. Extreme moves in thin conditions may overshoot fair value, and liquidity providers step in to fade them. But the tendency isn't universal. Moves driven by genuine information, like news, may continue.

A good study separates spikes by cause. Spikes without news, in quiet hours, show stronger reversion. Spikes after data releases show weaker reversion, and sometimes continuation.

The definition of "extreme" matters. Using a multiple of recent ATR or standard deviation adapts to current volatility. A fixed pip threshold doesn't.

Execution is the other problem. Fading a spike means entering as price is moving fast, with wide spreads and high slippage. The retracement may be profitable on a mid-price basis and unprofitable after real costs.

Testing with tick data and realistic execution assumptions is crucial before trusting a reversion strategy.

A sanity check is looking at how many spikes occurred in total, and how the profitable ones are distributed. If most of the profit comes from a handful of spikes in a few unusual sessions, the strategy depends on rare events and may not be reliable.

How is an extreme move defined, and what's the measured reversion rate after costs?