Sunday, December 19, 2010

Existential Volatility

Here lies a short post regarding the decline in market volatility. May it soon rest in peace.

This last week, due to the further trend of reduced volatility, combined with the season (my SEC Celebrity Hawksters calendar indicates we're into mid-December now), I changed gears and traded ahead of market moves instead of following along right behind them.

I had a little help. Besides this period of the calendar being a little easier to trade in general, by late in the session Wednesday I found most everyone I follow (good traders as well as my fade-parade) leaning on the negative side.

There was a scent of rat, I'll grant us that. The most pronounced warning signs included a distributive deterioration of leadership growth Monday and Tuesday, coincident to modest gains in the Dow and S&P500. You never want to see the leaders falling while the Dow is shining, if you're long. And recent extremes in measures of bullish sentiment have become perhaps an even greater concern.

But Rome wasn't wrecked in a single work week and even if we are setting the stage for trouble ahead, topping is more of a process and less like an event. The market was stable late in the session Wednesday, unlike Monday and Tuesday and I pressed onto the accelerator; ahead of any turn higher.

Now, when volatility is high and especially when measured moves tend towards severe, front-running these directional moves can be deadly; while keeping just slightly behind the market can be a license to print money.

We all like to demonstrate our brilliance and insight, but the act of anticipating direction in a volatile market creates occasional tremendous losses when you happen to get things wrong (known to happen). Such setbacks even-out and sometimes obliterate ones more brilliant, cowboy profits.

I'm much more profitable in the long run saving my spurs for special situations only. There are some very good traders who can do manage to get away with this (Jim Rogers comes to mind), but you need to be extremely rich and importantly - extremely right. Anyone else making a routine of getting ahead of the trade is extremely dead; sooner or later.

When volatility shrinks, however, as long as I'm reading the market well I'm more or less obliged to position ahead of moves. If not, I end up mediocre compared to my benchmarks, like so many other pros (client money is well aware most money managers under-perform index-funds and index-ETFs, and it has a way of disappearing when a simpler, cheaper strategy is generating more profit than you are. Fortunately for me, I'm an independent thinker and not afraid to go against the herd when I see the opportunity, but I am also willing to go with the herd as long as the music is playing. Unfortunately, however, I was not born a computer. So while I may have demonstrated a nice history of out-performing my peer group, my peer-group has turned into a machine; a machine that is still improving relative to my former peers and indeed, myself as well).

We saw lower volatility before the world began blowing-up in 2008. Volatility from 2005 to early 2007 was low enough that I was beginning to fear my days were numbered. The machines are better in this environment, better than I at squeezing the most out of a lackluster market. Fortunately for me, when the shit hit the fan and volatility exploded in 2008, a large number of machines were blowing-up right along with it, spectacularly in some cases. For a time I was able to capitalize on programs and typical human pros alike, neither of whom were equipped for what was taking place. Perpetual white swan models and long-term value beliefs were getting a major dose of - irreality.

Anyway though, it's clear the machine is only going to get only smarter, while I am myself (and maybe you) will only evolve weaker, certainly on a relative basis. It won't happen overnight (three cheers!), but I suspect it will announce itself more in a period of lower volatility.

In that case - long live higher volatility!

Note: I'm (still) working on a couple of larger posts, which might be good if they are ever finished.

Follow Centrifugal to fade trades in real time

Total Position: Currently 1.31-to-1 net-short, 107% invested

Currently Long
(according to size): PPO (9.6%); WLT (9.5%); CRM (9.1%); BA (6.1%); COH (6.1%); OVTI (re-increased Friday, 6%); SYT (6%); ARBA (re-loaded Friday, 6%); NOV (6%); RVBD (5.2%); BEXP (4.9%); BSFT (added Friday, 4.9%); VRA (thin, added Friday, 3.3%)

Currently Short: AAPL (added AH Friday, 10%); GMCR (7.1%); DSX (6.7%); VMC (added Friday, 6%); DISH (5.9%); ERTS (re-loaded Friday, 5%)
Note on AAPL short - this is a temporary hedge stemming from the distributive close on Friday. I will be covering early Monday if there is no sufficient market selling pressure. I expect to trade AAPL short again on December 31st, for different reasons. I'll discuss in better detail before then.

Futures: no current position. Traded-out March 10-yr long Friday at 119'31 (from 118'30 Thurs); Traded-out March Silver long Friday, 29.175 ave. (from 28.845 ave. thurs.).

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