Do you feel lucky, punk? Do you? Ranked volatility is suggesting that now is the time to be buying, for long-term buyers. The setup has been right 72% of the time. The problem: Is it different this time?
One of David Varadi’s premium indicators ranks volatility. It looks back in time and compares current volatility to volatility in the past, and ranks the result on a scale of 0 to 1. Looking back over the past 252 trading days (one calendar year) , we see that ranked volatility is higher than it has been in over a year. Hat to Jeff Pietsch over at ETF Prophet for directing my attention to this.
So what happens when we buy such extreme volatility?
- Yesterday, Ranked Volatility = 1. Today, Ranked Volatility < 1. Buy SPY at the Close.
- Sell X Days Later (from 1-100 days).
- No commissions or slippage included
- All SPY history used.
Obviously, buying when volatility is high, relative to the last 252 days, works. However, during a true Bear Market, buying volatility can lead to disaster. (See spreadsheet below, noting 2008 results). There is likely a method to mitigate the disaster, but I do not intend to write about that tonight.
What I’d like to highlight is how the results above suggest a change in the character of the market. These returns are generated by holding the trade for 100 trading days.
From 1994 to 2000, there were 6 trades that generated double-digit gains. (Yes, I’m aware there was huge Bull Market). From 2001 to 2007, there was only 1 trade generating double-digit gains. Despite a huge bull run of almost 100%, there have been no double-digit gains generated from 2008 to the present day.
I’m not sure what this all means. I just think it is significant. Perhaps the old adage about buying when there is blood in the streets has run its course. Maybe even Warren Buffett, who is famous for buying panic and disaster, has so thoroughly popularized the methodology as to render it impotent.
Are You Feeling Lucky?
Past history shows that we have arrived at a significant buying opportunity for long-term holders. More recent history suggests the edge is wearing thin.
The market always seeks to remove money from the naive, and the naive are much more likely to be swayed by emotion. Since high volatility is very likely to increase the influence of emotion and increase investor anxiety, I personally have difficulty believing that buying when there is blood in the streets is losing its edge.
Therefore, I’m Nibbling Tomorrow
Look, I’ve been saying for weeks, if not months, that we will be trading in a volatile range. A re-test of the current bottom is very likely. While swing-trading high volatility markets can be very, very profitable, short-term trading in these environments is best left to professionals. For everyone else, this is the time to deploy a small amount of cash in accounts that run long-term trades. Make sure the amount of cash deployed is small enough not to cause extreme angst should the market continue tanking but large enough to contribute to the long-term success of the account. In other words, don’t bet enough to cause you to sell at the bottom if the market trades much lower, but do bet enough to ensure you are rewarded for buying such a challenging (but potentially very rewarding) market.
Here is a graph of all the trades made based on the setup, over the last 7 years. Green arrows show the buys, and red arrows show the sells 100 days later. The lower pane displays the indicator. Finding the bottom looks easy with this indicator. Knowing when to sell, as always, is the hard part.