PRICE BEHAVIOUR AND MARKET COMPRESSION !!!
Certain Traits of Price Behaviour
1.
Trouble
runs in streaks – Market turbulence tends to cluster. The size of price changes
clearly clusters together. Big changes often come together in rapid succession,
and then come long stretches of minor price changes.
2.
Markets
have a personality – Prices are not driven solely by real world events, news
and people. When investors, speculators, industrialists, and bankers come
together in a real marketplace, a special, new kind of dynamic emerges –
greater than, and different from, the sum of the parts. Fundamental process by
which prices react to news does not change.
3.
Markets
mislead – Patterns are the fool’s gold of financial markets. The power of
chance suffices to create spurious patterns and pseudo-cycles that, for the
entire world, appear predictable and bankable. But a financial market is
especially prone to such statistical mirages.
Bubbles and crashes are inherent to markets. They are the inevitable
consequence of the human need to find patterns in the pattern less.
4.
Price
levels/changes exhibit some kind of irregularity regularly. The charts
sometimes rise or fall in long waves, or with small waves superimposed on
bigger waves. But none of this phenomenon – clusters of volatility, or
irregular trends – resembles any of the cycles, waves, or other patterns that
characterize those aspects of nature controlled through well-established
science. There are no familiar sine or cosine waves, with regular periods. These peculiar patterns cannot be predicted;
and so humans who bet on them often lose. Yet there clearly is a system to
them. It is as if the charts have a memory of past. If the price changes start
to cluster, or the prices themselves start to rise, they have a slight tendency
to keep doing so for a while – and then, without warning, the stop.
(Source - The (Mis)Behaviour of Markets -
Benoit B. Mandelbrot)
Nature of Price movement
throughout history remains constant, it clusters. Nature of clustering might change, but it
will cluster. Natural/Business cycles are smoother and clustering is far apart,
while markets which are not allowed to clear and constantly intervened (one we
are having since 2008-2009 crises), clustering is frequent and sharper.
Volatility/Price move clusters
(90-95% of price moves happen in 5-10% of time) , however in order to be active
we tend to trade regularly and in process use energy and money. Trading
regularly and trying to capture all moves, mind becomes monotonous and we trade
big moves and small moves alike. Ideally big moves should involve bigger bets
and small moves should have smaller bets.
Clustering is very natural to almost
everything....
1) Nifty
Nifty % returns since last 2 decades...Most of the gains or
losses are accounted by 2 mths....
2) In the 1980s, fully 40% of the positive returns from
S&P 500 index came during 10 days – about 0.5% of the time.
3) Look at a map of gold deposits around the world: you see
clusters of gold mines – in South Africa and Zimbabwe, in the far reaches of
Siberia and elsewhere. Same for oil and other natural resources
4) Top 1% controls 42% of financial wealth in America..similar
statistic will apply to other countries in terms of wealth distribution
5) From 1986 to 2003, the dollar traced a long, bumpy
descent against JPY. But nearly half of that decline occurred in just 10 out of
4695 trading days. Put another way, 46% of the damage to dollar investors
happened on 0.21% of the days.
6) Such clustering can be applied to everything in daily life to
marriage life as well....Most of the love (physical) between couples happen
during initial years (or months) of marriage then it's all infrequent
love....
7) Large part of population lives in very small part of
place....Mumbai might account of 0.001% in terms of area but will account for
2% of population.
There can be plenty of more examples...
Applying same to Market Trading...
1) Best way to play this clustering
is through options...because it allows one to play magnitude of moves
irrespective of direction..
2) Timing is very very crucial to
this because very small time accounts for very large part of the move....as we
have seen in above Nifty movement...2 Months accounted for almost entire year's
movement consistently for last 2 decades...
3) If one can be sure of direction then getting those clustered
movement is immensely beneficial....however even if are able to understand that
markets are about expand its movement...playing that expansion can also be very
beneficial...
2012 - Compression of Markets (Nifty - India) reach
extreme....2013 will it be to the other end ??
Big Yearly Compression
1) Number of weeks with movement of more
than 4%
2012 had lowest
number of weeks with movement of 4% or greater. There were only 3 weeks with
movement of 4% or greater. Average since
1994 is 11.
2) Summation of High-Low Monthly range
a) The above
table provides high low range on monthly basis since 1995. December 2012 so far
has the lowest high low range (1.4%)
since 1995. Previous lowest number was 2.34% in August 2001.
b) Red box
indicates high low range of less than 3%. each one of them were followed by
sharp rise in range in the following month.
Yellow box indicates range between 3-4%, while pink box indicates range
4-5%. Typically such compression are followed by at least 5%+ high low range in
the following months. Average range
expansion following red and yellow box is 9%.
c) 2012 was the
lowest in terms of summation of range score since 1995. Score stood at 74,
while previous low was 76 in 2012. One thing which stands out about the market
since 2008 is 2010 was the most compressed year since 1995 and with gap of one
year i.e. 2012 turned out to be the most compressed year since 1995. Thus, 2
years - 2010 and 2012 have been extremely compressed which is a very rare
thing.
3) High Low Range for the Year
a) 2012 has been
the lowest in terms of high low range for the year at 27.8%. Previous low as
29% in 2002.
b) 2012 is also
the year wherein in terms of absolute % movement, difference between high low
range and close-start range, is lowest.
Monthly Compression
Though yearly compression will inevitably
result in monthly compression, sending few set of data points to show monthly
compression as well.
1) Summation of Absolute (%) daily
movement on Monthly Basis
a) the above
table provides summation of absolute % move
on daily basis for each month. for eg summation for December 2012 stood
at 6 (over period of 16 trading days), giving daily average move of 0.38% or
20-22 Nifty Points.
b) Average
Monthly score for 2012 stood at 15, which is lowest since 1994 (previous low of
17 each in 2010 and 2002)
Other Factors...
VIX and options
pricing have fallen similarly since June 2012.
Central Banks
have largely killed volatility since June 2012, resulting in extremely
compressed market for so long. Given natural tendency of market to revert to
mean, 2013 could be very volatile.
