While high volatility may cause the blood pressure to rise, it can also signal higher average trades and better win percentages for mean reversion setups.
The recent surge in volatility is typical for a market that is in correction mode. Sprinkle in a possible nuclear meltdown and it is not at all shocking to see the $VIX gain 20%+ in one day. While this can be scary for the uninitiated, there is sublime symmetry found in volatile markets: They don’t typically move in one direction for very long before changing directions. This is not to say that over a period of weeks that a volatile market won’t have a large, extended move. Its just that the move will be broken into up and down days. For the gifted trader, trading this type of market can offers generous opportunity. For everyone else, when caught on the wrong side of the trade in volatile markets, relief tends to come more quickly than in trending markets.
In order to demonstrate what I mean, we will look at Daily Mean Reversion (DMR) in low volatility vs. high volatility markets. DMR simply means that if the market has a close lower than yesterday’s close, you buy (or cover), and if the close is higher than yesterday’s close, you sell (or short).
For this demonstration, I will use $VIX to measure volatility. I like $VIX because it is accessible to even the most inexperienced traders and it has plenty of history to use for testing.
Rules:
- Buy the close (or cover) if it is lower than yesterday’s close
- Sell the close (or short) if it is higher than yesterday’s close
- A $VIX threshold of 25 will be used
- No commissions or slippage included
- All SPY history used
Results:
Note the significant differences in the average gain/losses. The win percentages also increase. The long average trade is large enough that if commissions are low and leverage is used, a viable system may be able to be created.
Bottom line: When the $VIX is above 25, if you don’t like what the market is doing, just wait a day.
I posted the following article in early March, and with $VIX surging more than 20% today, the implications are still very applicable : VIX Surges, Uptrending. What Happens Next?
so if I understand correctly this means:
when VIX > 25. sell the rip in SPX
that makes sense as I was expecting a bounce to 1300 but maybe that is too obvious
That’s pretty much it. Short-term mean reversion works better in higher volatility environments.
Another careful, clear, and well presented analysis.
Trending or Reverting, on any and every timeframe, is one of the key questions, along w sector strength and weakness, in setting up one’s basic bias.
Always appreciated for these sharings, Mr. W’shedder!
No problem! Thanks!
Very clear and very helpful
Your extensive scholarly research shows that GOD has given lot of wisdom.I have traded many financial assets over last 30 years as private trader, educated through school of hard knocks.
I am a retired MD in NYC area & I actively trade.I have one question.For a given stock in a given time how often is occurence of M size move compared to 2M size move.My studies over 20 years conclude that M size move should be 4 times more common than 2M size move—based on square root of time principal for option pricing/odds of move of a given size in the underlying in the BLACK SCHOLES formula. BLACK SCHOLES may not be perfect–but the fact remains that trillion dollars of derivatives are traded each day based on this formula & option market makers make money year after year & laugh all the way to the BANK.Similar to relationship between price of one month option versus price of 4 month option,If it takes one month to get M move, it would take 4 months for 2M move in the same stock in the same time period.This tells me that if human brain is kept out of the equation & in SYSTAMATIC(automated) investing in stocks, take profit be 1/2 the size of stop loss( & we already know that markets are RANDOM) then over thosands of RUNS investor shall make a whole lot of money.Out of four trials one makes one dollar 3 times & loses 2 dollars one time with net profit of one dollar–all one has to do is that when take profit is HIT, cancell the unfilled stop loss order & repeat the process over & over.Investor stays direction neutral at all times with no bias long/short.This is not just a theoretical question–if you spend few hours pondering this question I bet your next 5 generations can make tons of money over the next 500 years,just clicking on the LAP TOP & would never have to look for A JOB.Any criticism would be appreciated.Thank you for your help in advance.
Dr Prem Nath MD email [email protected]
***Edited to remove his cell #*** Wood
I will have to think about that. I agree with it taking 4x as long to get to 2M. The question is, how do we select stocks that go up, consistently? What is there to keep us from choosing loser after loser that just hits our 2M stops?