November 6, 2020

Volatility Brief

Here is a long term buy rule that streamed across my Twitter feed last night.

When the $SPX punches in 4 straight gains of at least 1%, it is a signal of a major low. According to the content provider, this has happened only three (3) prior times since 1938 on 10/11/1982: on 10/14/1974 and 6/1/1970. He says, “All three occurred soon after major stock market LOWS.”

What is missing in this pattern – this rare setup – it has only happened after a bear market, each occurrence is preceding a decline exceeding 28%. Whereas the current low only marked a mild correction, thus far, of 8.5%. It’s just not the percent decline that lacked context for the “risk-on” signal by content providers. Rather the three lows used for this rule generated panic extreme readings on TEM our volatility model, including the panic index. Comparing that to the recent low that did not hit a washout extreme.

Contrary Thinker views the 10/30/20 low as a high-risk low, where we prefer washouts lows that provide low-risk entry. The big difference in these types of low is the panic extremes are clear via the models where the emotional background for the majority of traders is “gut-wrenching” making it difficult for the majority to buy, to go “risk on.” This market is still the bull market in fear; and vulnerable.

The market has an engrained myopic view mixed in with a long term bullish bias, not seeing the forest from the trees.

The Bottom Line

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