Before you get around to making trades, theres a great deal of preparation and testing necessary to develop a solid trading system. In the first of two articles detailing a swing-trading system, we look at the groundwork involved in constructing a thorough and accurate test environment.Mean-reversion systems measure the extent to which prices differ from a typical, or average, value. They enter trades by determining if price is at an extreme and anticipating it will return to its mean.

Some familiar methods of identifying such extremes include indicators such as the stochastic oscillator, the relative strength index (RSI), the commodity channel index (CCI), as well as Bollinger Bands, Keltner bands, and the z-score.

This article — and a follow-up next month — illustrates the process of developing a mean-reversion trading system based on the z-score, applies it to several different price series, and observes its behavior.