It’s been over 120 days now since the market volatility peaked so we wanted to update the analysis and add in new thoughts and observations. Recall that we focused on market sell-off events that had a volatility spike 7X greater than the total average volatility of the Dow Jones 30 for a period from 1985 to the present pandemic. We also used a simple definition of volatility as the 10-day moving average of the standard deviation of open-high-low-close prices divided by today’s closing price.
The graph below has been updated to show the data for the last few weeks. The green line shows the volatility indicator for the COVID19 sell-off when the numbers were elevated 10% above the historical average (this is an arbitrary cut-off we used to mark the beginning and end of the lines and definition of the volatility event). The volatility returned to normal levels on July 27 which is exactly 100 trading days after the peak on March 18, so we’ll end the graph there.
As you can see, the lines look quite similar in shape and timing with the volatility returning to normal levels around 100 days after the peak (with the exception being the second wave of the 2008 financial crisis).
As we covered in our July 4 email blog, the significant difference with this recovery is that the market is 20% or more higher than the prior two events (even though many economic indicators are significantly more negative). This reality is likely related to a wide array of actions taken by central bankers around the world pumping trillions into the economy through various (creative) mechanisms and delivery systems. This time may actually be different. The central banker tactics developed and employed during the 2008 financial crises may become the new normal. Here’s at least one data point suggesting the answer is maybe, and it may actually work (in the short-term).
As we committed to in a prior email blog, we’ll work on developing some type of mechanical trading system to take advantage of the next spike in volatility. The year-to-date Forte results show that we were successful in avoiding the big sell-off, but how can we now capture the rapid recovery typically shown in the above table when future opportunities occur? We sometimes use a simple graph as a starting point for a math model. The graph below zooms in on the peak events.
A simple model that may work would be to buy the Dow Jones 30 tracking ETF (DIA) when the market volatility is no more than 10% above the long range average and sell it when volatility exceeds 10% of the average. Then, if a large spike 4-7X higher than average occurs, buy back when the slope of the 10-day moving average is down and some type of inflection point in the line occurs. It’s simply one approach that we’ll consider having a model in place for ahead of the next sell-off.
After returning to normal levels of volatility on July 27 and staying there for 8 trading days, the market returned to higher levels of volatility and has remained there since August 6.
Forte Strategy Update
We executed 11 trades last week using the Nasdaq 3X leveraged ETF (TQQQ) for a net loss of 2.1% compared to a gain of 0.6% in the S&P 500. Our YTD net results so far are a 0.2% gain compared to a 4.4% YTD gain for the S&P 500. Our YTD max drawdown is 9.5% compared to 33.9% for the S&P 500.
More details about our trading activity can be found by registering on the Collective2 website and searching for Forte Strategy. A running list of these email blogs and general information about Maestro Capital Research can be found at maestrocapitalresearch.com.