Education
Now Reading
More On Quant
71

More On Quant

by MoleFebruary 1, 2012

Mole did a nice piece this weekend- and I do not have much to share for an outlook- but thought I might elaborate more the stats. I know none of you just want to be quants, but it will (1) help you understand my stat data; and (2) will help you formulate ideas about trading the tape.

The reason I like stats, is that it rids me of bias, but many use it as a false crutch IMO. Heck many give probabilities, but do not consider the real underlying distribution. Let us start with some robust growth rates compounding over say 14 periods.

This is why many use logged SPX charts when going back to 1950. Things look flat at the beginning, but they were not; the blue line is constant growth. Here is the natural log of the data- do you see the difference? This is the dilemma with regular statistics- we presume that returns are “normal” or “lognormal.” However, I am going to give you some charts to show you that the stock market is a bit more complex than meets the eye.

This shows us why so many use LN (natural log) to adjust PRICE for ROBUST growth rates. Again we are adjusting price for growth.

So here is the SPX price vol. and VXO distribution since 1986.

Clearly this does not look like a good bell curve- now this is vol, not asset returns – there is a difference as VOL is always positive and it cannot go negative. Consequently we use lognormal (LN) distribution.

So here is the adjusted data (natural log of VOL).

So I know you are confused- but the point is that vol needs to be looked at on a natural log basis. The fit is actually very good. This means that the VIX and actual SPX vol are both lognormal- but if they are lognormal we have proved the SPX returns must not be normal. So go re-read this again and notice how I said we use LN to adjust PRICE for robust growth. Here we are adjusting VOL for robust growth- not price. I know your head hurts, but let me bring this to real world practicality.

(1) we know from Mole’s post that the SPX has different distributions when VXO>25 or less than 25; moreover, we know that the market has kurtosis. This means markets tell traders to buy low and sell high, and little moves are common. However, that is not a good idea IMO.

(2) we know from the chart above that (a) both SPX and VIX vol are lognormally distributed; and (b) the VIX distribution is > than the SPX in terms of VOL- aka IV trades at a premium to actual SPX vol.

(3) All of this proves that William Eckhardt and Nassim Taleb’s beliefs. The market is more exponential than you will ever believe. So find a way to use this to your advantage.

(4) You must understand this to survive trading. How can one have an opinion or expectation on the market if one does not understand how markets work?

(5) Nothing is ever simple, but it probably is seasonal.

Here is a horrid chart of monthly implied lognormal VXO distributions. My point here is that all VXO distributions are normal- but none have the same shape. This means that one cannot apply the population to the sample- the sample IS a separate population! Notice below the huge differences between the summer and fall.

Now here is a more practical chart. I will just say the JUN is the complete opposite of OCT.

This shows us that in OCT a VXO >30 is has over a 20% probability- whereas JUN is < 5%. Get my point? Also, OCT has a higher probability of the VXO being less than 12- just to make you more confused. That my friends is the difference between an AUG sell-off and a SEP sell-off. In any circumstance- each month is different.

Ok so I know your head hurts, but keep the main points in the back of your mind. Things LOOK one way and act another. Distributions can be 1 seasonal and 2 conditional. In any case there is more than meets they eye. So when it comes to trading, I suggest building ideas that reflect the true nature of the market.

-Volar


About The Author
Mole
Mole created Evil Speculator amidst the chaos of the financial crisis in early August of 2008. His vision for Evil Speculator is a refuge of reason, hands-on trading knowledge, and inspiration for traders of all ages and stripes. You can follow him and his nefarious schemes at various social media waterholes below.
  • http://practicalt.blogspot.com/ Gold_Gerb

    niiiice.
    but I think i’m still confused between vol & VOL.
    any charts over a year, I certainly use logs due to YoY % change.

  • Anonymous

    I was stopped out quickly at .0680 last night apparently.

  • Anonymous

    “my brain hurts” … brings back memories – ahhhh, the full, glorious spectacle…of Gumby Theater

    http://www.youtube.com/watch?v=7_ofPVUhO3U

  • Anonymous

    5 min ZL not to enthuzed!

  • Anonymous

    Are we still working on a possible RTV Sell Setup…possibly today?

  • Anonymous

    I believe so…must happen within 5 bars of significant high & NOT pass the significant high.

  • Anonymous

    Anybody know if Facebook is listed now?

  • http://profile.yahoo.com/KUX3YSFLQNPISYDDKWOXQ3BOGY Vigilant

    Do not understand why everyone thinks FB will be trading today, they only submit papers today so they can be scrutinized.  By May or so, we should see paper flying.

  • Anonymous

    OK, thanks. That is what I thought.

  • http://profile.yahoo.com/KUX3YSFLQNPISYDDKWOXQ3BOGY Vigilant

    They knew the markets would be horrific in Feb/March?   haha, just wishful thinking….   But gotta be quick to see if they are trying to make a top on the FB IPO whenever they announce the actual date, may be a great sell the news event.

  • Joe_Jones

    5 min Zero says short that bitch

  • http://evilspeculator.com molecool

    Your best post yet, Volar :-)

  • http://evilspeculator.com molecool

    … and then there is Volar!

  • Anonymous

    Yes sir!

  • http://evilspeculator.com molecool

    What really stuns me is that all of these months resolve into a bell curve. I mean who would assume higher odds of a VXO below 12 in October? But the data suggests just that.

    Volar, have you re-run these numbers only with QE years! Meaning starting at 2008? Too small of a sample size?

  • TwinTurboRX7

    I thought they submit papers last june.

  • Anonymous

    Looking like a bear flag 5 min.

  • Anonymous

    http://content.screencast.com/users/AMCabrera/folders/Jing/media/a61c3a92-91ce-4086-b1ae-54b29a25fade/2012-02-01_1105.png
    blacked out oval it has already resolved, bias was able to get the better of me here. Clearly a nightie night when I said “lousy” one yesterday. But has I have already said 1350 is where the roasting temp will be really nice. Resetting Im taking USD/ZAR short profit off the table and stopping that trade for now. It was a really nice flag ship. Sticking a short order at 1.08 and 1.07.

  • Anonymous

    Mmm I just took a look at the order book for the AUD/USD. This pair in a longer term view could go back towards 1.09. It looks for the moment retail is positioned short more than long. with more sell orders lined up at 1.0750 OR that could be where longs have set the take profits. We will see.

  • Anonymous

    AMC – who do you like as a forex broker? 

  • http://practicalt.blogspot.com/ Gold_Gerb
  • Anonymous

    I started off with OANDA. I still use it. I like it more than MB trading. Those are the two I have used for forex trading with OANDA being the better one to me at least.

  • Anonymous

    Mr. Gerbil – I haven’t seen any “T’s” or fans from you in a while…what’s the latest?

  • http://practicalt.blogspot.com/ Gold_Gerb

    like I said to NYSE a few days ago, a few disappointments.
    but this just in.
    Click my name, or this link  http://practicalt.blogspot.com/2012/02/denied.html

  • Anonymous

    Thank you!

  • Joe_Jones

    Wow, if this is the case I think I’ll take a brake from trading for a while

  • http://practicalt.blogspot.com/ Gold_Gerb

    it backs up fearless, and binve, and now Mole with his latest post.
    also, the BPSPX has NOT rolled over.
    yes risk is high at 80, but we’ve seen risk hang out long periods of time in the high range.

    It could all be chaulked up to the dropping dollar, I just looked now, and yep, UUP down some more.
    (chart to follow)
    -GG

  • Anonymous

    A doji on the hourly would be fine with me.

  • Joe_Jones

    All I know is that I am really getting fed up of this nonsense

  • volar

    my jing not working.. look at NDX breaking out of resistance line- not bearish

  • http://practicalt.blogspot.com/ Gold_Gerb

    understood.
    most of my worst trades was when I was swimming against the USD unknowingly.
    as you know, the Market can go up, when the currency goes “Zimbabwe”.

  • volar

    thx mate- will look into the FED. in any case what we do know is

  • Joe_Jones

    The market has become impossible to trade. I am more and more realizing that I better get on with my life and do something else.

  • http://practicalt.blogspot.com/ Gold_Gerb

    I’m just about there.  Dropped the options games.  overnights were KILLING me.
    not to mention theta, beta, alpha, omega, vega, delta, and 3 other fraternities.
    😉

  • Joe_Jones

    It’s probably why we haven’t heard from BobbyLow in a while. 

  • Anonymous

    I see the Hourly non smoothed zero wedging.  Anything over a 1 in either direction should be good for something.

  • nyse

    Mine either. Weird.

  • nyse

    There she goes:  
    http://content.screencast.com/users/nysenyse/folders/Jing/media/6e4e17da-7b5c-43a2-b3a3-70003f0a611b/2012-02-01_1117.png
    I see three different scenarios playing out 
    – Green: if we break out of descending channel and LT resistance, then we shoot up to 1380ish near 23% retractment level (from 2007 highs)
    – Blue: if we dont break out of channel, we test lower range
    – Red: if we break out of lower range, then we drop to 1250

    p.s. Who knows.

  • nyse

    Me too.

  • nyse

    This really is a sick post. Well done, broda.

  • Anonymous

    Volar, is that 3d chart (awesome, btw) of the actual data, or of the bell curves representing the data? I mean, it’s just sooo smooth.

  • Anonymous

    I’m no quant.

    However, ‘technically’, I think that the months resolve (as shown in chart #4) into ‘skew normal” instead of a ‘bell curve’. Volar mentions this when he notes the “slight upward skew” on that chart. I think the cause for this shows up fairly well in the final chart – the ‘center’ of the june bell is higher and to the left, while the ‘centers’ of the other moths are lower and to the right. If, for example, one of the non-june months were to have a lot more kurtosis and have a center further from june’s, a more non-bell shape would arise.

    Considering the chart where the ‘sub-populations’ (months) are shown, I wonder if there is more evidence that the kurtosis increases as volatility decreases. I also wonder if there are other ways of creating sub populations that highlight that. Anybody know?

  • Fibz

    Anyone ever notice how companies tend to start hiring around market peaks? I still have my resume online somewhere and just got an email from Garmin. Took a look at their stock and of course it looks like it will be a good short soon. lol

  • Anonymous

    Is OANDA and ECN? I think MB was. If I recall Mole’s post, ECN’s are preferable.

  • Joe_Jones

    lol!

    Ask to be paid in cash not shares.

  • Anonymous

    Ahh the ECN question. Here where my thoughts about 3 weeks ago on the subject of ecn brokers. “Paging Fibz. FXCM..Why not try Oanda. It is a market maker but it is a really large one. Every market has a market marker in the end so dont let that deter you. They are a very large one which makes it much better, tight spreads, and I have never had a issue with orders. Orders are fully automated so technically like a ECN, except to me better because you can trade any size does not have to be a mini or standard lot. I remember using FXCM, forex.com demos and I was re-quoted ON A demo on both back when I was testing forex brokers. I have MB trading account too, they are ok. But I like Oanda better it just seems they have deeper liquidity with the banks they are partnered with. Which is why I really do not care if they are a market marker as long as they are a very large one. In the end the volume of orders Oanda handles exceeds or is at par with the biggest ECNs out there and are just the same.”

  • Anonymous

    Not only hiring, but also think about M&A and IPOs. AOL and Time Warner in early 2000 comes to mind, but there are a lot more examples especially for high-profile IPOs (Facebook anyone?).
    Actually, this makes sense if you think about it in terms of social mood. The stock market is just one expression of optimistic mood and it is easy to see because we can create charts. But these expressions of mass psychology aren’t restricted to the markets, they influence everything from business to politics to personal matters.
    You can say and think what you like about Prechter’s forecasts, but I think his theory of Socionomics makes a lot of sense than the EMH or random walk theories when it comes do describing the world.

  • volar

    tis normal dist of the data- i will say they all are very fitting so it actually was fine by me to use the normal dist.

  • bshah

    what’s going on here…  some big locomotive pusing SPX train from behind.. as if a target in mind.. Insanity or what ? why AAPL is not participating ?

  • Joe_Jones

    [EDIT in reply to bshah] MM are pushing SPX to exceed recent highs at 1333.47.
    Let us see if they make it. If they don’t, we’ll likely have a failed retest of the top.

  • nyse

    Are we seeing a ZL divergence yet? Too soon?

  • Fibz

    Agree that economics is a social science. It seems natural that companies would hire around peaks due to their profits/revenue increasing. If their numbers were declining, they wouldn’t be hiring. On increased hiring, profit/margin curves will begin to skew, which is probably why the market tends to decline on improving job numbers.

  • Joe_Jones

    Definitively on the hourly. ES signal on the 5 min is kind of small to tell.

  • Anonymous

    I can see your point, but the lavender, puce, & maroon scenarios are more likely to play out in my mind. :p

  • Anonymous

    I agree, except that earnings always describe the past but hiring is about future expectations. If companies are recruiting, it tells us that they expect the future to be even better than the past or else they wouldn’t need additional personnel. If they expected lower forward earnings, they’d probably try to make due with what human resources they already have in anticipation of the downswing.

  • Anonymous

    It’s an uptrend day, so divergences don’t mean all that much. I wouldn’t want to go short here without a break of VWAP.

  • Anonymous

    I like it when the ZL makes those little hooks:) Check out the one before the ramp. Probably nothing.

  • Anonymous

    I respectfully disagree.  Hiring is not about future expectations.  I’m not sure how it happened other than an ill informed media that irresponsibly pumps financial news to find some reason for whatever the market does when it opens.  Until about 3 years ago, employment was considered a lagging economic indicator, not a leading indicator.  
    As a business owner, I do not hire with future expectations in mind nor do I know anyone who does.  Companies pay overtime and/or drive productivity to fulfill CURRENT demand.  This approach deals with inventory levels, depletion, and leveling.  My labor requirements are entirely determined by my current demand and inventory levels.  (I admit that there are exceptions in sales & marketing, but those areas are relatively small in comparison to production & operations.)  It’s all about balance, but the impact on a company’s bottom line causes it to err on the side of depleted inventory rather than sitting on unused inventory.  

  • Joe_Jones

    “It’s an uptrend day”

    So far…

  • Joe_Jones

    I like the shapes of the latest SPX 60 min candles

  • Anonymous

    Ya, better than a doji. Next one closed below a just maybe……….

  • nyse

    Thanks man

  • http://practicalt.blogspot.com/ Gold_Gerb

    SPY at the Captain Obvious line again.
    here at EvilSpec, in order to cut down on precious resource waste, we recycle charts when possible
    We are an evil shade of green

    http://evilspeculator.com/?p=26674#comment-421503277

  • Joe_Jones

    You crack me up!!!
    😀

  • Joe_Jones

    Unless we get a senseless, out of nowhere, MF melt-up, thinks are shaping up in the right direction
    😉

  • http://evilspeculator.com molecool

    ¤ø„¸¸„ø¤º°¨¤ø„¸¸„ø¤º°¨ 
    ¨°º¤ø„¸  N E W  „ø¤º°¨ 
    ¸„ø¤º°¨ P O S T “°º¤ø„¸
    ¸„ø¤º°¨¤ø„¸¸„ø¤º°º¤ø„¸

  • bshah

    todays price action in certain stocks is just weird.. AAPL, ORCL, etc..  just don’t show much dramatic move even with push high and now tracing back.

  • http://evilspeculator.com molecool

    Just use 2011 charts – we basically started 2012 just like 2011.

  • http://evilspeculator.com molecool

    LOW probability though…

  • Anonymous

    Always good to conserve those electrons, Gerb. They come in handy

  • Anonymous

    more likes than the original. nice.