People are obsessed with winning streaks. In the context of US cash equity markets, a more important concept might be non-losing streaks, the definition of which follows:
- Pick a threshold percentage that represents an “acceptable loss” or stop-loss
- Starting at zero, count each consecutive day where the daily loss isn’t enough to trigger the stop-loss. If the stop-loss is hit, start counting again at 0.
This is intuitive because of the ubiquitous use of trailing stop-losses in equity trading. As we can see from the chart below, it has been 787 trading days since the last daily decline of 3% or more in the S&P 500 index. That’s over 3 years; it occurred on November 10th, 2011. With trading’s turnover rate, an entire generation of algo traders hasn’t experienced an equity decline of this magnitude.
Predictably, spikes in the spot VIX have tended to occur after the breaking of non-losing streaks. The breaking of a streak results in a persistent increase in volatility for a period of time. When multiple breaks happen close together, each break ratchets up vol another notch. Note the series of breaks in 2008-2011 which correspond with a series of VIX spikes during that time.
It turns out this kind of good fortune has happened A LOT over the last 64 years. The longest streak is an astounding 2860 trading days, or over 11 years. The distinctive saw-tooth pattern evokes “arrival time” or the exponential family of distributions used to study failure rates. Perhaps it is an example of a fractal at work, as the charts for 1%, 2%, 3%, 4% declines and so on all resemble one another just with a change of frequency. Perhaps a revisit of multi-fractal volatility is in order…
It would seem there are similarly amazing non-losing streaks at every stop-loss threshold. The chart below plots the current number of years that have elapsed since we have experienced the daily decline given on the x-axis.
This would suggest a watch and wait approach to trading volatility spikes. The opportunity to buy volatility exists only after a breaking of a streak (breaking multiple streaks within a short time period is the best indicator). At other times selling vol dominates.