I recently came across a paper which makes a case for reducing equity exposure during periods of volatility.
https://www.anderson.ucla.edu/Documents ... o_2016.pdf
"The main finding in this paper is that investors should substantially decrease risk exposure after an increase in volatility and that ignoring variation in volatility leads to large utility losses. The benefits of volatility timing are on the order of 50% of lifetime utility for our preferred parameterization of an investor with risk aversion of 5 and a 50 year horizon. These benefits are significantly larger than those coming from expected return timing."
I will admit I didn't read all 50+ pages, but there seems to be a good argument here. I guess the key is in how you time the volatility. Anyone doing something similar?
Volatility Timing
Re: Volatility Timing
I'm playing around with a new momentum/trend following strategy learned from Tom Basso that seems to avoid volatility relatively quickly. Keltner Bands. Currently reviewing 1.5 and 2.5 ATR settings, 10day historical ATR, 20d EMA. The main theme is to be long (unhedged) when $SPX above the 1.5 band. If price on $SPX crosses the 20d EMA downward, 50% hedge/exposure. If price on $SPX crosses lower 1.5 band, 100% hedge/exposure. All entries are based on close (above 1.5 band). Hedges/exits based on stops (can be triggered intra-day). Stops adjusted daily or every few days.
If done in current environment, would've missed most of the downdraft and had you waiting patiently in cash. Strategy seems to have caught most of the 2017 upside. The strategy will only make $ in a higher momentum market. Will be on sidelines in sideways or downward market. I see it as a capital preservation strategy in higher volatility, while capturing moves higher over the med/long term. When charting and looking at recent price action since early Feb, there are interestingly many bounces/closes right on the keltner bands - both above and below 20d EMA.
If you take a look at recent drawdowns over last 5 years, strategy seems to perform particularly well. It's a purely technical/price play - probably not for everyone. I like the fact that its a slower moving strategy - should be less ins/outs - not so much daytrading in volatile environments.
Please rip apart for any looking into it. Would love to hear devils advocate side.
If done in current environment, would've missed most of the downdraft and had you waiting patiently in cash. Strategy seems to have caught most of the 2017 upside. The strategy will only make $ in a higher momentum market. Will be on sidelines in sideways or downward market. I see it as a capital preservation strategy in higher volatility, while capturing moves higher over the med/long term. When charting and looking at recent price action since early Feb, there are interestingly many bounces/closes right on the keltner bands - both above and below 20d EMA.
If you take a look at recent drawdowns over last 5 years, strategy seems to perform particularly well. It's a purely technical/price play - probably not for everyone. I like the fact that its a slower moving strategy - should be less ins/outs - not so much daytrading in volatile environments.
Please rip apart for any looking into it. Would love to hear devils advocate side.