Frequently Asked Questions

Dr K VIX Volatility Model
These markets are becoming increasingly irregular in the way they trade. Please comment.

A member sent us this the other day:

Regarding the VIX spike buy signal you refer to in your message of 10:40 earlier today, Lawrence G. McMillan wrote the following in a Sept. 15 MarketWatch article:

"The VIX spiked higher last Friday and continued to spike even higher on Sunday night, when stock prices were down in Europe overnight. Based on that Sunday high for the VIX, a “spike peak” buy signal occurred atMonday’s close. This is a first time occurrence, for the VIX has only been pricing at night for a few months. Prior to that, for all the years that the VIX has existed, it was priced only during NYSE trading hours. Hence, it is unclear whether this is a valid signal or not. So far it has not worked out very well."

Fortunately, the VIX Volatility Model (VVM) does not depend on this factor. That said, it goes to show that markets do change, and certain material changes to markets since QE started in 2009 have certainly affected trade. The key is to see how such changes can be of benefit to a trading strategy while accounting for any changes in risk.

For example, 2009 was a fiercely powerful bull market year yet the trend following wizards, a group of top performing fund managers, collectively finished the year down This was due to strong quantitative easing (QE) manipulations which rendered many indicators invalid. It also created an uptrend the market had not seen before, highly choppy and irregular, yet the major averages finished 2009 up hugely. Incidentally, the trend following wizards also finished 2011, 2012 and 2015 down. 2013 was roughly flat. This is an unprecedented occurrence.

The Market Direction Model (MDM) accounted for this in early 2009 so was able to handsomely benefit from the change. Then new challenges via additional forms of QE were thrown at the markets. For example, the S&P 500 was unable to stage any meaningful corrections in 2013 as QE would put artificially shallow floors under the major averages. Consequently, despite 2013 being a year of the anemic uptrend with 2 steps forward, 1 1/2 steps backward, the worst drawdown for the S&P 500 in 2013 was a mere -7.5%, also quite unprecedented.

Irregularities and manipulations will continue as long as QE remains the global dish of the day. Over the last few years, we have adjusted the way we trade to account for material changes in the way stocks trade. For example, we have advised members to buy constructive weakness while keeping stops very tight in this unforgiving market environment.

As I recently wrote:

I have examined the last few days of trade from September 9-13, 2016 which are irregular. The irregularities are smaller than those that occurred in August 2015 but irregular nevertheless. The VVM has accounted and adjusted for this new data in the name of risk control. For example, the automatic rebuying of XIV after a VIX spike buy signal will no longer apply.

While risk control is the most important rule when it comes to investing, the VVM can sometimes use material changes in markets to its advantage. The highly irregular flash crash in 2010 and more recently in August 2015 exaggerated volatility to extremes. The VIX spike buy signals profited immensely from both occurrences.

So while some may be losing confidence in the way markets in general trade, every problem contains its own solution. Our vigilance and focus remain of utmost importance when it comes to investing.

Published: Sep 18 2016