On June 30 I rightly urged caution for pairs traders. I use a paper-trader account to monitor real time futures pairs performance in larger sizes and varieties than I normally deploy. At the end of the month, the trades began to fail more often than not and the net liquidating value of the paper account began to shrink. My real-money trades worked through the end of the month, but I cut them short quite often. I know now that this transformation of the market corresponded to the drain of volatility from the market place. As the volatility drained, the prices of equities rose like zombies. Without volatility, one could not capitalize on the spasmodic noise of random prices. When the market rose in a 2+ standard deviation move, the market became lifeless. It was yet another quasi black-swan occurrence under the influence of Fed monetary policy.
It was as if the river suddenly began to run lower due to decreased summer rainfall and increased agricultural use. In certain coastal streams of Oregon, this makes fishing onerous, hot, and dreary. The best tries are simple and short returns to the tried and true deep steelhead holes at dusk. The beautiful fish lie in the deep pools during the heat of the day; they move to the swirling deep falls in the evening. Put a fly in the right place, a summer steelhead might take the bait and run with all its might for its life across the once quiet aqua. But that is it. Floats are worthless (you’ll run aground); the sea-run cutthroat trout have come and gone; and the trout need a rest. When one isn’t fishing, one can hike the hills, tend to the garden, and get ready for the rains of November.
Back to market reality. In this up market, only those who took long positions when the market broke down on higher volatility in May can claim victory. I envy and salute those who took long positions when the market looked weak. The brave hands had to sleep through some rough nights I bet– perhaps relieved in part through scaling strategies. In any case, there is good reason for traders to keep a good portion of their portfolio in long-only index funds that are managed on a simple 20-month moving average trend system.