Markets Change…So Should Traders

01/30/2012 3:30 pm EST

Focus: TRADING

Rob Hanna

Co-Founder, Investiquant

Trading in unprecedented market and volatility conditions requires certain adjustments, says Rob Hanna, explaining how he has adapted his trusted indicators and methods to keep pace.

Rob Hanna is my guest in the MoneyShow.com Video Network studio, and Rob, you’ve been trading for a while now; what have you seen change in this environment?

Well there have been a lot of things that have changed as far as what works and what doesn’t over the years. I use a lot of different types of indicators, and the use of those indicators will change sometimes. 

What indicators do you use?

For instance, if you’re looking at breadth, years ago, if you would see a day where 90% of the volume was to the upside or to the downside, it was a pretty rare day; you might get two or three or four of those a year.

In the past year, we’ve had closer to 40 of them, and that’s something that changed around mid-2007, early 2008. You started seeing more and more of what I refer to as “herding,” where everyone is going in the same direction.

Stampeding, actually.

Exactly, yeah. For a lot of tests, if you run them back for years and years and years, and you ask, “What’s happened after there has been a 90% down day in the market,” for instance, well, that meant a lot more years ago than it means now, so I’ve had to adjust a lot of my breadth indicators.

One thing that I do is I look at how they’ve done compared to all other days over the last year, so rather than just saying we had a 90% down day, for instance, I’ll put a percentile rank on that over the last year. 

It finished in the bottom 1% of all days over the last year, or in the bottom 5%, or the bottom 10%, or whatever it was, and then I’ll run backtests on its percentile rank rather than the actual raw value of how much it’s gone down.

What’s another indicator you look at?

I look at sentiment and volatility and all kinds of indicators along those lines.

Well we certainly know volatility has changed.

Yep, that’s gotten a lot higher for the last three years.

So how do you adjust to that?

Well that’s a little bit tougher to adjust to. Again, you’ve got some pretty good historical data, and what I do in all my tests is if I run a test showing a spike in the VIX of, say, 20% in one day, normally, the next day you end up getting a rebound in the market. 

After a 20% volatility spike, what that tends to do is it means a lot of people got scared that day, and most people get more scared than they should. So the next day you’ll often get a rebound.

From the overreaction?

Right. So we may have had more of those days recently, but I haven’t seen a decline in their usefulness as I have with, for instance, breadth studies.

It’s important to monitor when you’re doing historical analysis not just what the raw numbers tell you, but you want to look at a profit curve or something along those lines to see if the edge has persisted consistently over time or if the edge waxed and waned.

Has it been consistent, something you can rely on, or is it something where you’ve probably got more potential reward than risk, but it’s still not consistent. So you want to look at consistency, persistency for a long time.

How about volume?

Volume again is a little bit tricky and that has meant different things at different times. A lot of the things they talk about with volume aren’t always true.

For instance, people like to see low-volume pullbacks, they say. Well, when a pullback starts on very low volume, you’ve had a strong move up, and say you’re at a ten-day high or a 20-day high in the market, and then you get a down day that’s on extremely low volume, so say it’s the lowest volume in the last two weeks or four weeks or whatever it is, there is a good chance that the volume is low because people aren’t worried, right? So a lot of times that pullback needs to increase to get them worried. 

Volume does a nice job sometimes when you’re looking at meanings of moves. There are a few things I look at; one of them is volume, and another is the position of the market, so if you have a 3% drop from a ten-day high, that means something a lot different than if you have a 3% drop and you’re already at a ten-day low. 

A 3% drop from a ten-day high and you might have further to fall; if you’re already at a ten-day low and you get a 3% drop, everyone is already scared, and now they’re totally scared, so you’ve got a much better chance of a bounce the next day or two or three.

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