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Volatile Systems
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Volatile Systems

by The MoleSeptember 10, 2018

You guys know I’ve been all over volatility, the realized and the implied kind, for a good part of this decade now. If you curious as to the reasons for my volatile obsession then the most salient one is that volatility is much easier to predict than signed returns. I’ve covered that topic in exhaustive detail over the past few years and today we’re actually going to put it to work.

Okay, I know it’s Monday and I promise to keep it light. Our mission, should we choose to accept it, is to leverage prospective realized volatility exhaustion periods as swing trading opportunities. To that end we’re going to work our way backward starting with early March all the way into today.

You probably recall the volatility indicator in the bottom panel. The formula of the base signal is rather simple: Calculate the daily ranges by subtracting the candle’s low from the candle’s high. That’s your range signal which you then can smooth via an SMA. From there simply slap a Bollinger on the beast and you’re good to go.

I’ve also added an SMA(14) to the price panel and in the center we of course have an SMA(14). My RV indicator has special logic that colors every candle that causes the indicator to breach > the upper BB and < the lower BB. The yellow candles represent breaches < the upper BB while the cyan candles mark breaches < the lower BB on the RV indicator.

So the first worthwhile observation here is that price and RV Bollinger breaches seem to mostly (but not always) run inverse to each other. Okay, let’s think this through: Does an exhaustion in realized volatility usually coincide with a low in sell off activity?

Many people actually make that assumption and at least on paper they are mistaken. Why? To quote Dr. Ernie Chan:

If [predicting realized volatility echoed] the accuracy for predicting the sign of the SPY return itself, we should prepare to retire in luxury. Volatility is easier to predict than signed returns, as every finance student has also been taught. But what good is a good volatility prediction? Would that be useful to options traders, who can trade implied volatilities instead of directional returns? The answer is yes: realized volatility prediction is useful for implied volatility prediction, but not in the way you would expect.

If GARCH tells us that the realized volatility will increase tomorrow, most of us would instinctively go out and buy ourselves some options (i.e. implied volatility). In the case of SPY, we would probably go buy some VXX. But that would be a terrible mistake. Remember that the volatility we predicted is an unsigned return: a prediction of increased volatility may mean a very bullish day tomorrow. A high positive return in SPY is usually accompanied by a steep drop in VXX. In other words, an increase in realized volatility is usually accompanied by a decrease in implied volatility in this case.

Okay, so the ability to predict realized volatility, on its own, does not offer us an exploitable edge in the market. And I’m not just parroting the opinions of the good Dr. Chan – I myself have spent years correlating price action with RV and thus far only saw limited benefit.

Of course that does not mean we shouldn’t attempt to throw in other alpha factors into the mix. Which obviously I am attempting to do here. If you again take a look at the chart above then you see magenta and yellow arrows. The magenta ones point toward times when see RV exhaustion (yellow candle on the price chart) followed by price breaching below and then recovering above the lower Bollinger. The yellow ones point to instances when there RV exhaustion follows a breach through and back above the lower BB on the price panel.

Well at least on this panel I see four winners and two losers. Not bad – let’s keep looking:

Here we’re looking at April and May. God how much I miss spring but fall is beckoning and is almost as good. Now here I see four winners – three and a half if you don’t count the first one. One rule I forgot to mention is that the yellow candle needs to flag < the SMA(14) – and it’s the opposite for the cyan candles (which we’re not covering today0.

May and June offer us three or four winners, depending on how soon you advance your stop to break/even.

Here we are in June and July. Three winners and that last one is clearly a loser. FYI I didn’t count the very first one as I don’t count RV exhaustions which are not followed by Bollinger breaches. The idea here is that I want to see RV roll over and slow down while price is producing some kind of sign that it’s ready to revert.

In this particular system we employ simple spike lows that managed to pop below the lower Bollinger. But you could use any number of alpha factors. Be creative!

Which brings us to the very last example terminating today. Things are looking good at first – I see three winners and two losers. Not sure if I really should count the one with the yellow candle near the SMA – I usually prefer those to be placed further away from the rolling mean.

And that finally brings us to the current formation which is a bit of a furball. First up RV exhaustion signals keep getting triggered here due to the compressed BB range on the RV indicator. Which is not something we see very often apparently. The very first chart from March shows us one occasion but that BB compression is near the floor, not near the top of the RV range. So what does that mean?

Could RV remain elevated or even expand further? Yes, absolutely. If we saw more whipsaw and intra-day volatility then this could go on for a while, producing several more RV exhaustion signals. Kind of when a stochastic or MACD becomes embedded in the upper range > 80% or so.

But what are the odds of that? Well, we have the technology – please step into my lair:

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About The Author
The 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 the usual social media waterholes.
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  • bankwalker

    Long Dec Silver 14.245 … stop 13.985

  • HD

    I’ll join you. Looking for $14.45

  • bankwalker

    that is a reasonable short term target for sure.

  • StockTalker

    Rut Roe, /NQ looks in trouble with APPL on sell.

  • http://gerb-reloaded.blogspot.com Gold_Gerb
  • http://gerb-reloaded.blogspot.com Gold_Gerb
  • HD

    Sept products roll this week.

  • StockTalker

    Time to die!

  • StockTalker

    Bears, put the feed bags on:)

  • HD

    On the topic of volatility. Here’s another look at the 9%’r I’ve shared before and was posting about last week. Daily money maker. Not swinger. Looks for <=1.00 from your favorite volatlity crush product.
    https://uploads.disquscdn.com/images/58d3fde57d7ed9674b1af6c17dff72025099c682dd71d88031b2d4f5aebe72a2.png

    will self destruct as I have shown this several times.

  • HD

    Some of the FAANG down ~20% from their ATH’s

  • StockTalker

    Watching the dollar, think 95 will be tested here and if it holds the party will begin.

  • StockTalker

    Tech in fairy land right now.

  • BKXtoZERO

    I have been looking for one more small lower low on silver

  • HD

    Thoughts on BTC? Big level here imo

  • HD
  • http://gerb-reloaded.blogspot.com Gold_Gerb
  • http://gerb-reloaded.blogspot.com Gold_Gerb

    excellent chart. Awareness is super important.

    Predicting, is a losing game. Play the odds.

  • Julie 35 – 25 – 36

    SLV Needs a bullish close above it’s 5 ema at 13.38 Today’s high 13.38 and pulling back
    JULIE

  • http://gerb-reloaded.blogspot.com Gold_Gerb
  • Julie 35 – 25 – 36

    SPX Today’s high could be the lower high to short Just under a 50% retracement
    JULIE

  • HD

    It was way more popular 8 months ago. Idk where all the BTC traders went? Great product, technical and pays well.

  • StockTalker

    IMO this market is not sustainable, have added to my short positions and now will sit on my hands.

  • HD

    If S breaks I think we can get 5,000 swiftly.

  • Julie 35 – 25 – 36

    HD Looks like a descending triangle from February
    JULIE

  • Mark Shinnick

    Don’t forget General George Patton: “Fixed fortifications are monuments to man’s stupidity.”

  • Julie 35 – 25 – 36

    John Paul Jones “Don’t shoot until you see the white’s of their eyes” SPX I am looking for the lower high to short and only then. No top picking attempt. One item my SPX charts last week depicting the upper middle trend line of Raff Regression Channel matching 2% above it’s 21 ema was on the nose
    JULIE

  • Julie 35 – 25 – 36

    GG AAPL The short is a lower high on the next bounce
    JULIE

  • https://evilspeculator.com Sir Mole III

    Boy – I love that one!

  • https://evilspeculator.com Sir Mole III

    Not a single comment is mentioning what I wrote today.

  • Mark Shinnick

    furball pretty tough work with Mole; nobody characterizes this scene any better.

  • HD

    “I myself have spent years correlating price action with RV and thus far only saw limited benefit.“

    Agree

  • BKXtoZERO

    Sorry Mole…. Most mornings PST I get up and don’t have a lot of time in the morning before work. I read it, the whole thing, and I did find it interesting. I noticed in the past, you had a few posts like “ready for volatility” etc…. and as a TVIX junky my ears perked up, but after a few I understood it to mean more what your post was about, that it doesn’t tell direction only increasing range. I did know enough that your last 2 posts on “get ready for turbulence” etc…. meant more pie in the bears faces.

  • BKXtoZERO

    8000 compx again seems likely to me…. waiting for gold stocks to show signs of a bottom, not doing much lately. NO TVIX for a while now….

  • Julie 35 – 25 – 36

    Guys $NDX https://uploads.disquscdn.com/images/9948ebb5150a98749b975415a872642a89cf30700046d838bc4af2565c6736a1.png Today a second failed back test of the broken lower trend line and confluence of the declining 5 and 21 ema’s JULIE

  • HD

    Looking forward to your TVIX streaks to return.
    The fact that your IV system was + 100% in just a few months was very impressive. It’ll come back.

  • Wave_surfer

    Still digesting it. Good stuff! Thanks for sharing.

  • BKXtoZERO

    Me too… But I did break some of moles rules getting there… Namely large positions but with very tight stops. Mkt conditions were perfect for that. Resistance points were observed and reversed. Fed meetings were nice short targets and when I was up on reversals I had a few holds and swings..

  • BKXtoZERO

    Reminder 9-11 tomorrow. Every one we get through is an excuse for a patriotic rally

  • HD

    +27 point rally last year, +44 year before, +22 year before that,,,,,

  • BKXtoZERO

    So is not just my perception. I distinctly remember being run over multiple times. I know what the underside of the vehicle looks like but never got a plate number

  • HD

    Ha. Only 1 red close for 9/11 in this bull
    Market. 2009 SPX closed -$1.19

  • HD

    TBH. 9/11. 17 years later I still am not satisfied with the explanation for 7WTC

    https://youtu.be/Mamvq7LWqRU

  • Mark Shinnick

    Far too clean and coordinated.

  • http://www.captainboom.com/ captainboom

    Question for the group: I’d like to be able to convert a SPY price to an ES price for the current contract quickly. I know it’s approx 10:1, but when I look at today’s prices, the Sep ES contract is trading below the SPY price if I just move the decimal to compare.

    Is there an easy way to do this? Maybe a consistent conversion factor I can stick on a spreadsheet?

  • http://gerb-reloaded.blogspot.com Gold_Gerb

    Half the reported victims bodies….were never found.

    https://www.dailystar.co.uk/news/latest-news/643029/september-11-victims-identified-twin-towers-conspiracies-world-trade-center-anniversary

    I tell my children, we will never get the truth. Just know this – “something, wasn’t right”.
    -GG

  • Mark Shinnick

    Yep….why the active spot sparks flaring before tower collapse.

  • BKXtoZERO

    Looked like demolition charges timed perfectly in 2 different corners right as it collapsed. Melting steel etc with burning jet fuel not being able to reach melt point for steel. Lots of fishy stuff… Plane into Pentagon did t even look like a plane

  • http://gerb-reloaded.blogspot.com Gold_Gerb
  • Benson Burns

    This stuff is where I’m spending my time at the moment, although my focus is on trying to ascertain whether IV skew is relatively high, low or indifferent, and if that can inform leg placement for butterfly spreads.. Skew has a greater impact on spread prices than is taught anywhere. Almost like a dark gamma.

  • Benson Burns

    Yuge level.

  • BKXtoZERO

    Layering into nugt 10% at 11.75 and just now 40% at 11.19. Maybe 9-11 is also a good day to drive metals even lower.

  • https://evilspeculator.com Sir Mole III

    Pro tip: In that context look at the VIX:VXV (i.e. IVTS) or the VIN:VIF which I find equally compelling.

  • HD

    Idk. Both SPY and ES derived from SPX which I think is a better conversion. Chart SPX, trade ES, SPY.

  • http://www.captainboom.com/ captainboom

    Ah, the dividend is what likely makes the difference. Maybe I can use that as an adjusting factor.

  • Yoda

    Bobbylow, if you read this, Hold on tight!

  • http://gerb-reloaded.blogspot.com Gold_Gerb
  • Ronebadger

    Good thing I didn’t move to Charlotte yet.