The first market development that we've seen the last few months is that we're all trading the same market. Above we see charts for the Ten-Year Treasury Note Yield, the Russell 2000 Index futures, the Yen/Dollar futures, and the VIX. Note how the Russell and Yen are near mirror images, and how the VIX is similar to the Yen. In early August, drops in the Russell began to correspond to declines in yield. As a result, we see falling yields when stocks are weak, Yen is strong, and VIX is rising. There's reduced diversification: currencies, stocks, fixed income; they're pretty much all the same.The second market development is that we're all daytraders now. Of course that's an overstatement, but the dramatic rise in volatility over the last year, combined with losses at banks and hedge funds, has meant that traders have to manage their risk intraday. That is helping to create significant volume and significant intraday market swings. I can't remember a period in which so many longer-term traders have stayed so glued to their screens, making decisions in a potentially reactive manner.
All of this is relevant to what you watch when you trade, how you size positions, and how you view your risk when positions are correlated. In the end, there's just two settings on traders' current thermostats: risk seeking and risk aversion. And the two are playing themselves out daily.
RELEVANT POST:
What's Carrying the Stock Market
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5 comments:
You couldn't be more right!!!
There's nothing else to say, as your post says it all :) .
BW
We all trade the same markets but fortunately, not in the same way...
Brett ~~~
No question, we all trade the same markets. And, yes, I can “see” that the Russell and Yen charts appear to be nearly mirror images of each other, and that the VIX appears to follow a similar trajectory to the Yen.
I don’t know about yours, but my brain seems to be wired to hunt for patterns and correlations. When I see patterns or correlations in images such as these, it’s impossible for me to know if they are real or illusory.
Maybe the need to see pattern and correlation is based in instinct, the need to recognize environmental features related to survival: faces of children, one’s front door, a stop sign.
Elliot Wave Theory, the notion that there are patterns of repetitive, nested waves in markets may epitomize this instinct-based need. But, trading survival seems to often require over-riding such instinctual needs and responses and behaving counter-intuitively, e.g.: do not take small gains.
When looking at seemingly inverse waves in diverse markets one might ask, is the action of one sending correlative (much less causative) signals to the other? Or, is it coincidental? The only way to know this is to do some careful number crunching.
To see what I mean, I invite everyone to perform a simple experiment:
Flip a quarter 300 times, carefully noting heads and tails. Heads = +1. Tails = -1. Record the results of each flip and build a chart of the results. Do this ten times. I feel confident that several of the randomly created charts will exhibit what appear to be correlated, or even inverse waves.
Adam.
Adam,
I believe there are statistical tests to determine the extent to which the correlation might be random. Perhaps Dr. Brett could enlighten us on those. Pattern-finding is how we are wired, but the fact is that sometimes the patterns really exist.
If you don't believe it's really there, that's fine, but I think there's a lot of opportunity for the traders willing to dig in. There's even opportunity in the overnight sessions for equity traders, again, if they dig in.
This was also happening in February and this summer, but I think this sort of thing might be hard to backtest. On the one hand, it seems like the strong correlations don't exist all the time, but only during certain 'moods' of the market. Regimes change, and that makes it difficult. On the other hand, how does one avoid confirmation bias?
I really believe we're seeing causation here. I've developed an indicator that lets me know when the carry currencies are getting hit hard. Needless to say, it was quite accurate on both Wednesday and today. There was loads of opportunity for either the currency trader or the equity trader as a result of the moves that actually began (this time) in the currencies. There have also been times where the flow of money has been the other way.
I don't know that I can fully convey what's been happening, but the correlation goes way beyond what you might see on a historical chart like these. If you were to watch the markets as they are making these types of moves, you would know what I mean (of course you'll have to be up around 3am EST to catch some of the starts). On moves like we've been having, you can actually see the money flowing through the markets.
I don't know how long this will last, but 'make hay while the sun's still shining.'
BW
Thanks for the comments on the post. I agree that the mind is wired to find patterns, even when those don't exist. And, of course, correlation and causation are different things. In the case of these variables, I do believe that risk aversion and risk seeking are the links among the markets, with the carry trade being an obvious source of correlation. I appreciate the insights--
Brett
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