Very interesting market action the last couple days folks. I will try to do a more detailed breakdown soon, perhaps in an upcoming video, but what we're seeing within the volatility markets right now is a perfect illustration of a crossroads that will contrast two types of traders:
Those who are contrarian and front-run, and those who are trend following and wait for confirmation of signals.
3-month chart of S&P 500:
You can see in the last couple days we've seen a nice little bounce in the S&P 500, and especially yesterday. However...
3-month chart of the VIX index:
The VIX index is holding very firm. Under normal circumstances when we see the S&P 500 recover like that, the VIX would get crushed. There's two reasons why this hasn't happened yet.
1) The minor reason is, markets have been choppy all year and there's been several times when it looked like a recovery was underway, only to see it crumble just as fast. Vol can be a little sticky in the higher price range the second or third time around. The old "fool me once, shame on you. Fool me twice, shame on me" adage.
2) The major reason is the G-20 meeting on Friday where we are likely to see some fireworks with respect to the ongoing saga of US China trade talks. If it goes well with some positive news headlines, I think it's safe to say we will see some significant volatility crush. On the other hand, if it doesn't go well, it's not hard to envision a scenario where all the algo's are pre-programmed for sell and we see another ugly leg down. And remember, those algo's make up the majority of trade volume these days so a move in either direction may be quite definitive.
So front run? Or wait for confirmation of the signal? This is a real investor philosophy question.
Now I hope I've made it clear over the years but just to remind newer members of the community. I never front run news headlines, I only trade by the math and follow my market indicators. Right now volatility is far too sticky in the high ranges to flash any signals to get into something new today. We will of course re-visit tomorrow but my guess is vol will stay firm until after any announcements are made.
So while I think there's a decent chance we finally see the wind taken out of the VIX sails on Monday, we have to acknowledge there's also a decent chance we see a violent leg down in the S&P if headlines are negative coming out of the meeting.
Let us recall February 5th, 2018. Remember, VIX was way elevated for a few days heading into the weekend. Back then, a lot of people were front running the vol crush, expecting to make some easy money shorting volatility into Monday anticipating it ahead of time. I saw an alarming number of tweets being sent out saying what a great time to short volatility it was. I gave many warnings about the dangers of front running when volatility is elevated.
Here were some of my warnings on Friday Feb 2nd, just one trading day before the termination event of XIV.
Now I'm certainly not saying we are set up for a repeat of Feb 5th, that was a unique situation. But just in general, remember that volatility gets elevated for a reason. Because sometimes, it's justified. So yes, volatility may crush after the G-20. Dare I say, that's probably the more likely outcome. However, sometimes it goes the other way.
And since risk is always asymmetric to the downside, it's never a worthwhile gamble to front run. Personally, I always follow the numbers and wait for confirmation of the signal. It does sometimes mean we're a little late to the party, but the flip side of that coin is, it may also protect against those rare and memorable days that derail years of progress with one mistake. It's just not worth it. Risk management first, always. Not sometimes, not most of the time, always.
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