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Home Archive for category "Market Risk" (Page 7)
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Finally Some Excitement

As intermediate to long term investors we often ignore the daily gyrations of the market.  We don’t pay a lot of attention to what happens during the day because most of the time it just doesn’t matter.  In fact, a lot of times we’re flat out bored and have difficulty finding things to talk about.  Our days are usually filled with waiting for weeks on end for something that changes the underlying technical structure of the market enough to change our portfolio allocations.  Those changes are usually in small increments so they’re boring events too.  I’ll even make the confession that I don’t have CNBC or Fox Business on TV during the day.  I have Fast Money in my DVR, but only because it runs an hour after the market closes so it covers earnings announcements.  Long story even longer, most of the time what we see on a daily basis is irrelevant.  However, once in a while we get near an inflection point where things can get exciting very

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Near Term Risk Rising

Ratio of VIX vs VXV signals stock market corrections

One of the charts that we like to keep an eye on to determine the amount of perceived risk in the market is the ratio between one month volatility (VIX) and three month volatility (VXV).  When the ratio is low, market participants believe that near term risk is lower than risk further in the future.  When the ratio rises it shows a sentiment shift from money managers indicating that they are getting fearful about the near term. If the ratio moves above 1 it warns that more people are fearful about the next month than those worried about the next three months.  As a side note there is a new volatility ETF (XVZ) that attempts to take advantage of this theory. Right now we’re seeing the ratio approach 1 telling us that we’re almost to the point where investors believe there is more risk of the market being volatile over the next month than over the next three.  Over the past several years this has been a point that marks

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Using Volatility as an Investment Hedge

Using Volatility as an Investment Hedge

The past fifteen years have been a very volatile time for the stock market.  Not only has the market had large corrections and bear markets it has also had huge rallies and bull markets.  These swings have made and broken many portfolios. An investor can limit the violent swings in their portfolio by implementing a hedging strategy designed to limit downside losses.  With the explosion of ETFs over the past few years there are now several investment vehicles that can be used as a hedge against extensive declines in the stock market.  One method that is gaining popularity among investors is volatility. The most common measure of volatility is the CBOE S&P 500 Volatility Index (VIX). When an investor buys a VIX future or option they are placing a bet that the variance or deviation in the price of the S&P 500 Index (SPX) will increase at some point in the future.  Basically it is a bet that the market will experience large price swings.  When the stock market declines

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It Doesn’t Pay to be Smarter Than the Market

Stock Market Health Indicators

  It doesn’t pay to be smarter than the market. Our core market health indicators mostly improved this past week, however everything but risk remains deep in negative territory. Our measures of the economy continue to slip lower as economic reports from around the world bring disappointment.  Our measures of trend slipped as well, however this is mostly due to the market stalling over the past month so we expect improvement if the S&P 500 Index (SPX) can stay above 1550 and ultimately break above 1600. Our measures of risk, quality, and strength all improved as the market showed resilience in the face of bad news.  That’s probably the most important observation we make this week.  There is virtually no perceived risk.  I use the word “perceived” because we see plenty of risk. But if there is one thing I’ve learned over my life is that it doesn’t pay to be smarter than the market. As a result, our hedged portfolio remains modestly long and won’t be aggressively hedged unless

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Long / Short Portfolio – 90% Long and 10% Short

Our Market Risk Indicator finally made it back to a positive reading this week.  As we’ve noted in our weekly market comments, our core market health indicators have been fighting against market risk.  While the market health indicators were strengthening over the past month our Market Risk Indicator stayed stubbornly negative.  With the clearing of our risk indicator we move from an aggressively hedged position to a 90% long position with a 10% short position.  The longs are stocks that we believe will outperform the market and the short is a simple short of the S&P 500 Index.  An ETF that can be used is SH. As always, we can’t see the future so we allocate our portfolios based on the probabilities created by the history of our indicators.  The current condition of our indicators suggests that the market should move higher over the intermediate term.  Once again, not a prediction, merely a situation where the odds favor higher prices. The current hedge ratio is .11. The green lines in

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Market Overview 12/29/2012 – Make or Break Time

S&P 500 Index with Twitter Sentiment

This is one of the times when I really wish I could see the future.  We have a market that is coiled like a spring, with conflicting signals as to which way it’s going to move.  But when it does move it will be so fast that most market participants will end up chasing price…and losing money in the process.  Since we can’t see the future, but we know that risk is high, we feel it prudent to position our portfolios for multiple outcomes.  In short, hedge them. We’ve been comfortably hedged or 100% cash since October 19th in our portfolios that use our market risk indicator.  We took a small profit on our longs and tightened our hedges again on December 19th.  Our hedged portfolio currently  has a slight bias to the downside.  We’re still holding most of our longs, but are hedged in a way that we’ll lose money if the market goes up (or sideways) and make money if the market goes down.  However, the gains or

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Which Way for Volatility (VIX)

Volatility (VIX) Twitter Sentiment

Over the past four months volatility (VIX) has been in an uptrend.  During October and November VIX spiked above 19 and has been slow in its descent back to the bottom of the up trend channel it is painting.  This shows that investors are concerned about the immediate future of the stock market.  We’re watching the bottom of the up trend channel and also the down trend line we’ve drawn from the late May peak to the early November peak for confirmation of the next direction for VIX  (and the market). In addition, we’re keeping an eye on our Twitter Sentiment indicator for VIX.  From the low made in early October our daily Twitter sentiment indicator confirmed the move in volatility.  However, during the move into the November peak in VIX our smoothed sentiment indicator showed a fairly strong negative divergence.  This resulted in VIX falling over the next month.  It traded back to near the bottom of the down trend channel and then bounced. We’re now starting to see

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When Risk Rises

Published on October 22, 2012 by in Market Risk
Market Risk Indicator

Last Friday our Market Risk Indicator went negative.  Although this puts us officially in warning mode it doesn’t mean that prices will necessarily fall.  For this reason, you should never use our Market Risk Indicator as a signal to go either long or short.  If you do, you’ll lose money.  Remember, hedging is not the same as going short. Over the last four months the market has rallied and is now consolidating.  This consolidation comes above very important support levels.  If we were to look at nothing but price we’d have to conclude that the market is simply pausing before moving higher.  Unfortunately, what looks healthy on the outside isn’t always healthy on the inside.  Our risk indicator is telling us that even though price is acting reasonably, risk is rising.  The red lines on the chart below represent our market risk indicator signalling a warning.  The blue line are when the warning condition was cleared. When market risk rises investors have several options available to reduce risk. In our

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Market Overview 10/20/2012 – Market Deteriorating

Twitter Sentiment, Support, and Resistance

What a week.  We’re in the same place as we were last week, but it doesn’t feel like it.  After making a trip to the top of the range and back down again we saw deterioration in many of our indicators.  Most importantly our Market Risk Indicator went negative.  This indicator overrides all of our other indicators as it often signals an acceleration to the down side.  We’re not predicting a break of support in the 1420 to 1430 range on the S&P 500 Index (SPX).  Rather we’ve been warned of a the chance of substantial risk so we’re buying insurance by aggressively hedging our portfolio.  We’re effectively 50% long stocks we want to own and 50% short, however, we’re using aggressive hedging instruments like puts that match our portfolio or mid term volatility (like VIXM or VXZ). Market Positives Our measures of the economy and trend strengthening slightly, however they are slowing in momentum. Financial stocks are showing better relative strength which would bode well for the market if

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Long / Short Hedge – 50% Long 50% Aggressively Hedged

Long Short Hedging Strategy

Our Market Risk Indicator closed the week in negative territory.  This signal caused us to aggressively hedge our portfolio.  We’re effectively 50% Long and 50% short, but our shorts consist of instruments that will benefit from increased volatility in the market.  Some examples are puts against our long positions or mid term volatility like VIXM or VXZ.  A lesser alternative would be an actively managed bear fund similar to HDGE. The long portion of our portfolio continues to be stocks that we believe will outperform the general market over the long run. This move in the portfolio is not a prediction of lower prices in the market.  Rather, it reflects enough increased risk that we want to insure our portfolio.  As we’ve noted before, our Market Risk Indicator has many false signals that are usually short in duration.  If this signal is false we expect to take a small loss which we consider paying for insurance.  If the signal proves to be correct we expect to make money as volatility

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