Tuesday, 22 November 2016

We Are In A Bubble

I have been following the S&P 500 for a while now looking for a short opportunity. I have created a leading indicator that anticipates market downturns using a series of data. I will not be going into details as to how the indicator was constructed but I will briefly explain how it works.

Above shows a graph of the S&P 500, my indicator (CRI - Crash Risk Indicator) and the Drawdown of the S&P 500.

The green line is the historical price of the S&P 500 and the blue line is my indicator. The red area on the bottom is the drawdown of the S&P 500.

The idea is when the CRI is above 0.5 (the horizontal black line), there is a potential of a crash. Doing some backtesting, there were 2 major spikes for the CRI which happened in the year 2000-2002 and 2008. If your memory serves you well, you would know that these was the Dot Com bubble and the Subprime crisis respectively.

In more recent times, the indicator spiked before the China devaluation in August 2015 and another one in 2016 January sell-off. The indicator recently touched the threshold in the past couple of weeks but it did not trigger a potential market crash as it did not exceed 0.5. However, I am monitoring this closely as the S&P 500 has reached an all-time high and I foresee a sell-off in the near future.

I cannot tell you exactly what the cause of this bubble will be, but I can say that the indicators that I use for my CRI is giving a very grim future.

My model is based on 4 indicators. I will list what are the factors that I consider for this model for you guys to get a better idea of that I am focusing on to determine whether or not the market is heading for a crash.

1. Moving Average
2. Error Adjusted Momentum
3. Option Adjusted Credit Spread
4. Market Regime

That is all for now, I will keep you guys updated with what lays ahead. As always, happy trading. Cheers.


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