Disliked{quote} Mr C, excellent PDF thanks, since you have the great ability to explain complex concepts so didactically, I ask you about the article and to put it in simple terms, how could the volatiliy, described by the author, be applied to daily trading ? is applicable? Moreover, how can a trader interpret volatility from the author's view in more flat terms? thanksIgnored
The article focusses on how the competetive efforts by the central Banks since the GFC and more particularly since 2010 have resulted in risk being transferred, magnified by government policy and further amplified by participant behaviour resulting in a 'surreal global economy' that has artificially high valuations and bearing massive levels of intrinsic risk. To trace where this risk actually lies however is a massive conundrum for any analyst due to the interconnected nature of our markets. The thing about complex systems such as the financial markets are that when inputs are supplied to such systems such as the gargantuan increase in monetary supply with no associated increased global productivity, growth in income equality and debt deflation, this input is quickly dissipated throughout the system across asset classes and is incredibly difficult to identify where it has been transferred to. The same occurred in 2008 where the impacts of toxic securitised mortage debt from the US were transferred by the holders of this toxic debt into the financial system and ended up in obscure places.
Despite the lessons of 2008, we really haven't learnt anything. The risk borne in the financial markets has grown significantly through quantitative easing policies. The too big to fail syndrome has not just been applied selectively, it is now a global policy applied by almost every Central Bank. As stated in the article, globally Central banks have printed over 14 trillion dollars since the end of the GFC and there has been a massive burst of competetion amongst the Central Banks to devalue their currencies to gain a competetive advantage. The result is that we have artificially high valuations of almost all asset classes you can think about......but still the money printing occurs.
The problem we face is that now there is nowhere to turn for the central banker or for the average investor. The Central Banks are too scared to pull the reigns in, and are in a prison of their own design.
Some of the symptoms we are facing now is a direct result of Central Bank policy. You may have noticed that volatility in the financial markets has been artificially suppressed. Furthermore you can see this suppression across all asset classes and their progressively building correlations. The reason for the growth in correlation across asset classes is the impact of this dramatic influx of worthless paper which needs to find a home in some asset class somewhere. Since 2010 mean reversion has reigned supreme with very limited volatility. The problem with this artificial suppression and a result of the markets bearing increased risk is that complex systems become more prone to fat tailed events. Furthermore participant behaviour has now been significantly influenced by the notion that they should buy every market dip and short every market spike with leverage as they are fully aware that government policy now reacts to market conditions as opposed to economic conditions and as a result, they can be confident that their actions wil be supported by the Central Banks. The predictable pattern of mean reversion is an attractive lure to traders *while it lasts* and government policy plus participant behaviour is leading to this predictability. HFT is capitalising on this predictable pattern....but the net effect of this predictable environment and associated predictable participant behaviour is a massive spiralling of risk in a non-linear way.
You can see the intrinsic risk buried in the financial system with the more and more frequent market outbursts we are experiencing. The VIX has recorded 5 supernormal 5 sigma events over the last 2 years. This is abnormal schizophrenic behaviour which is alarming many policy makers.
You are aware of Martingale systems J. Well what is happening today across the global markets is a massive Martingale event where intrinsic risk is building in the market. This can theoretically go on for a long time.... The Central banks have been doubling down, the market participants have been feeding on this frenzy and a growing storm event is building on the horizon.
As a trend trader, while these conditions continue you need to have faith and stay the course. Continue to manage risk like the devil....but you need to be in it to win it. Do not lose the faith and throw in the towel. Crisis alpha is coming our way. We don't know when.....but the market conditions and symptoms are suggesting that our day in the sun is soon. There has been a massive divergence occurring between the real economy and the drug induced 'surreal economy' we face today. Today moral hazard is embedded in the markets.
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