More on Breadth Models

I’ve experimented with a few breadth models in the past. My hypothesis is that markets have become so efficient and correlated, that all (profitable) strategies break down into long vol or short vol profiles and at the end of the day, your profit will STILL be determined by the movement in the underlying. While utilizing an options structure might benefit or alter the structure of your payout, the extreme inefficiencies that once existed are probably gone and your ultimate profitability over the long run is determined by how well one forecasts’ the underlying.

So momentum jockies know this well and wait only for up-trending markets to trade. If that’s the case, then is momentum trading simply leveraged long in the underlying? Similarly mean-reversion strategies can perform extremely well in ‘stable’ environments and exceptionally well in high to low vol regime shifts but can easily get rocked in low to high vol environments.

Anyway, below is another simple model to forecast equities based on market breadth statistics. I like it cause it’s simple, green = short vol strategies, red = long vol strategies. The model just turned green, hopefully it’s the start of a new bull market! After trading through 08/09 and the recent Euro crisis, I much prefer low vol, uptrending markets. Profit margins may be thinner but far less stress.

~ by largecaptrader on January 16, 2012.