This Time IS Different

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  • on November 16th, 2011

Surely others are skilled enough to do it, but I’m finding it incredibly difficult to grab opportunity here.  Correlations(fleeting as they are) are off the charts, and a vicious feedback loop is thwarting trending efforts in both directions.  The measurement that seems most “off” to me is $VIX, which has stayed persistently high in the past week or so despite a compressing range and lack of a price downtrend; directional movement has dwindled to nothing as measured by ADX.  It feels different than any environment I can recall…is it?

My “cocktail napkin” data mining says it is.  Using the default reading of 14 days for ADX, we’ve now traded below 12 for 3 days in a row for only the 11th time since 2000.  That’s not ultra-rare, but since historical volatility is an input to the widely followed $VIX statistic, I’d expect a lower reading for $VIX as well.  A look at those 11 instances mostly bears that out as follows:

For the most part, the churn built into a low ADX reading coincides with a “lull you to sleep” reading for $VIX…but not today.  We are all anxiously waiting the next bad news, or good news, or breakout, or breakdown…so implied volatility remains fairly high.  Of these instances, the only one that bears a resemblance is late December 2002, when we were in between a low and THE low.  Whether or not you believe that it’s possible to repeat that episode, I thought I’d at least share the following chart from that period:

Now decide whether it bears any resemblance to the following daily chart with which we’re all becoming tired of watching:

Erik Swarts is the master of executing the analog approach and always challenges my thinking with pictures like these.  I approach each day not in the context that scenario #2(today) will travel the same path as #1 but that each moment is unique; this moment looks really unique.  My take is that the combination of low ADX and high $VIX requires vigilant risk management but also an understanding that neither of those conditions is likely to persist.  We’re all watching closely because the outcome seems so important, and I totally agree with that logic.  Much of the frustration stems from the lack of either a) a sustainable trend in MY time frame of weeks to months or b) notable divergences between breadth and $SPX to provide a definable low risk setup.

I’m all for the idea that day to day price changes contain a HUGE element of randomness, but to work ADX down towards 11 indicates a marketplace unprepared for a trend.  We’re all being trained like Pavlov’s dogs to fade the fringes of this range, but whether it takes a day or a quarter the better use of my time is to get aligned with the resolution and not the range.  Individual stocks and sectors will be the first to go, and should let us know when the thermostat is de-activated and new trends can be joined.  Now, if someone wants to share their favorite way to position for an $SPY or $VXX resolution without paying high IV I’m all ears…

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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