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So What About Market Correlations? (a new series)

December 8, 2009

Listen carefully when I tell you that volatility and correlation are the two most important and useful factors in determining stock returns. Two good blogs that discuss these topics- more so volatility,  are Jared Woodward’s  Condor Options  http://www.condoroptions.com/  and    Bill Luby’s Vix and More http://vixandmore.blogspot.com/.

These two factors are dissected by academics and option traders for a reason: a) they work more reliably than most factors b) they give sophisticated players and edge–most traders can’t understand how to use them, or are unwilling to put in the time. Most of what goes on in stock charts we tend to view singulary in a two-dimensional plane. In reality, the market is one gigantic multidimensional puzzle that is both correlated and cointegrated.  A stock is but one planet in a larger solar system, and is similary pulled by invisible forces that humans took hundreds of years to discover. Neither stocks, commodities, or anything else that is publicly traded exists in a vacuum–nothing with the exception of over the counter instruments move only to the beat of their own drummer. Attempting to visualize intermarket relationships at the short term level is nearly impossible for the human eye. Its hard to tell what leads or lags what. But that’s ok, because it allows those with computers and statistics to see things that you cannot. Now I’m not trying to sound like an advertisement for canned intermarket software, but these things are important to recognize. Like it or not, we are all in some kind of arms race for higher profitability, and those who don’t have nuclear weapons are at a distinct disadvantage. I will try to go through some examples and applications, but as you can tell, I’m excited about the things that I have “discovered” that many people have known all along. So stick around……..you might see the market beyond 200day moving averages and of course (ahem) DV2 and other (cough) good DV  indicators. :o)

to be continued…………….

3 Comments leave one →
  1. December 8, 2009 11:41 pm

    Thanks for the mention, David. It’s always nice to be in any list that has Jared’s name on it.

    As for correlation, I wonder if you think the CBOE’s Implied Correlation Index is long enough in the tooth to take seriously. While it was launched in July, the CBOE does provide historical data going back to 2007: http://vixandmore.blogspot.com/2009/07/cboe-launches-implied-correlation-index.html

    Cheers,

    -Bill

    • david varadi permalink*
      December 9, 2009 12:32 am

      hi bill, good to hear from you. I have already done testing on that data. While there isn’t as much of it as I would like, the results are superior to using historical correlations and function in the same direction as historical correlations. I have backtested historical correlations using much longer backtests. Thus I have confidence that it will be similar to VIX vs historical in terms of efficacy out of sample. But as always I will keep track of the relationship vs historical to ensure that it remains stable and predictable.
      cheers
      dv

  2. Ramon permalink
    December 9, 2009 6:24 am

    I feel a ‘DV Dispersion’ indicator in the brewing!

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