Friday, November 09, 2007

We're All Trading the Same Markets

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.


What's Carrying the Stock Market