Paratrade Systems Weekly Research News

3 Mar

Climbing the Wall of Fear

Fear is what keeps buyers away. We need some to stay away, so they can come in and buy later. When everyone is long because no one is afraid, then there will be no buyers left. At that point, we should be scared.

The Trump rally has been associated with general consternation about disorganization and policy vagueness. At the same time, there is optimism about possible (huge) corporate tax cuts and new government spending. In the long run, the US may go bankrupt but for now – it’s great for earnings.

We had an unusual case yesterday when the market rallied substantially after the Trump speech. Fear rose. I’m defining fear as Implied volatility/ Realized Volatility. I substitute my synthetic function for Vix as a proxy for implied volatility.

FearVol blog

It’s normal for fear to fall when prices rise, and the converse. We can see this in the chart above.

Fearvol blog 2

Here you can see how yesterday the market had a big rise and yet volatility-adjusted fear rose. Let’s look at the 5 day average:

Fearvol blog 3

Now we can look to see how the market behaves if this 5 day average is higher than it was 2 days ago:

fearvol blog4

You can see how this method of filtering holding days returned approximately 1300 points over 12 years. Doing the opposite lost money – in a largely rallying market. The market will be in trouble when rallies are associated with significant declines in fear, not a declining (negative) beta in that regression.

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