A study by the New England Complex Systems Institute did a Abstract earlier this year hypothesizing that market correlations, when reaching extremes, precede a crash.
http://www.necsi.edu/research/economics/economicpanic.html
Are markets more correlated now than last year? Last decade? It sure feels that way. Just watch the equity markets; it’s all up or all down. I’m afraid that as the correlation reaches above 90%, combined with HFT, that instability will dominate, then overtake.
And how about today’s action?! End of quarter markup interrupted by a bit of headline risk…And precious metals are up on the thought that the Euro Bailout must come from somewhere. What if it doesn’t come? Care to think about that?
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Well, let’s see:
– Bespoke Invest: “All or Nothing Days On Pace For Record Year”.
– Shiller’s survey of investors after the 1987 crash: they sold as a reaction to the news of the market dropping and not a fundamental reason (i.e. everybody else was selling, so I did too)
– Sornette’s book “Why Stock Markets Crash” has chapters such as: Herd Behavior and Crowd Effect; It Is Optimal to Imitate When Lacking Information; and Cooperative Behaviors Resulting from Imitation.
Looks like you’re on pretty solid ground. Doesn’t guarantee a crash, but the conditions are in place.
“And precious metals are up on the thought that the Euro Bailout must come from somewhere. What if it doesn’t come? Care to think about that?”
PMs will go up in that event, too. No brainer trade.
Since the central bankers setup the CDS market, caused it to default, and then refuse to write the CDS debt off the books, it’s pretty much guaranteed a few currencies and economies are in their crosshairs for a system reboot.
Really? Looking at a chart of 2008 I’d say the no brainer trade is to short PM’s during a liquidity crises. But maybe that trade is already over.
If Euro doesn’t get bailed out do people really want to be long gold and silver, or do they want to be short Euro’s ie buying USD? What’s safer?
the highest court of germany,”16 judges” has already said that this esfs cannot go forward unless the constitution is re-written and can only be done by the vote of the people. that is why merckel is down on the elections there.the people dont want her, or the bailout of anyone. that is why this has been dragging on.with out the constitution being rewritten this will not happen. but look at it on the other hand,mr market is having a wonderful time faking the hell out of everybody while skimming all our money with all the faked out rumors every twenty five minutes.
Great article… However, I believe the findings create a bit of a paradox. When markets are easy to predict, things are about to get ugly. But if everyone knows that and adapts accordingly well ahead of time?
The herd is generally wrong, so it is not surprising that when everyone starts trading in unison and engages in “group think” that the crash is not far away. You can’t have high stock prices or low stock prices, or even ordered moves if no one is willing to take the other side of the trade. But knowledge of these findings could indeed potentially start to create more structured hedging if enough people read that and took corrective actions. Same thing with the awareness of potential “black swan” and hedging to protect against it. The shorts and puts will create floors when they cover to rebalance and take profits, it is when everyone suddenly doesn’t know how they are going to hedge or when at the same time that they move to cash and there isn’t a short that wants to cover of anyone who wants (or has the capital) to buy that is the issue. People panic sell and determine they will sort things out later but when everyone reacts this way, this is where things get real ugly, real quick.
In 1987 we had “portfolio insurance”. Yes, that’s what it was called. When your basket of stocks started to decline, you would sell an equal amount of futures. The arbs were supposed to keep prices in line. Well guess what happened?
Now we have HFT’s. Some of us realize that they add no true liquidity to the market, but they add a lot of instability. Look at the “flash crash” if you want evidence.
Stuff happens. I know for a fact the people that are trading and have never been caught on the wrong side of a market when the circuit breakers kick in will be in full panic mode dumping boatloads when they can trade again.
Personally I do not think it is coming.
The message from Greece and the Eurozone will continue to be “positive” and that it is coming. (damage control while praying for a solution.)
A mess indeed.
Great post!
Can you think of any positive solutions that are actually possible?
usually yes.but if it comes from an outside source,and they cant get credit for it,then they wont use it. ask christina rohmer(sans),why do you think she left this administration.
Interesting. A couple of us that were around in 1987 have been saying how similar the current market feels to the couple of weeks pre-crash.
Of course that doesn’t mean we will, but it doesn’t hurt to be prepared.
I wasn’t trading then (just owned mutual funds) but Yogi you are absolutely right. If you look at option premiums from that period they were all over the place; people were scared one day, confident the next. The market was in an unstable region and we saw the consequences.
BTW, there was a small chance that the market did a melt-up in 1987, instead of a crash.
Commence the fearmongering! 😉
I am a kid with 3000 bucks. I made 140 bucks with FXF this year and 350 with DGP in August. That is all I have ever done. What should I do now? I’m holding AGQ right now. This money is for my trading account not staring at so don’t tell me to get a CD or a treasury bonds. I already have investments I don’t want to buy aapl shares. I have been reading this page for a month now and you guys seem to have balls. Do not dissapoint my impatient immature ass. I dont know shit about the market, I just feel like I do so I play with my money. My Macro 101 professor says I should buy a treasury bond. I think he should teach ethics. Please don’t ban me dudes.
Why would you be banned? I think you will find iBC to be very supportive of new traders.
Only advice I have is do the opposite of me. That should work pretty good for you.
well what are you not doing now moober?
Can’t offer you much advice on what to buy or sell. I can say this:
1) If you trade a lot commissions will eat up your money really fast. One trade at $10 is 0.3% of your capital – that’s huge.
2) With this level of capital you can probably only take one or two positions at a time, and you’ll be 100% invested with nothing in reserve. So, volatility can wipe you out very fast.
3) Holding cash until a trend is established is an option. But, this could be months.
*I have 3000 cash not in AGQ