Which Market Regimes Dominate

Aug 05, 2021

(originally sent to subscribers December 22, 2020 - sign up here)

Today is like any other day for me. Wake up, read for a few hours, hang with my son, go for a walk listening to an audiobook or podcast, fire up the monitors, launch zoom and get to work in the trading lab. 

I've been working on slicing and dicing a bunch of data and as usual when I go into these data slicing modes, I generate a bunch of new interesting insights. Or rather rabbit holes. sometimes, the rabbit holes are fruitful, sometimes I just get to sharpen my data skills. Either way it's a win!

This week I wanted to work with Market Regimes, as I do. No surprise there. 

Here are some of the insights I gathered in my work so far. 

Instead of the typical "A bear market is a 20% decline from the highs" or any other random statement about the markets, I use a tool called the SQN (Systems Quality Number) to help me organize market regimes. 

The SQN measures the past 100 trading days close to close, square roots that, then averages it, then divides by the Standard Deviation. 

Or more simply, it measures the direction of the assets

  • Bullish
  • Bearish
  • Neutral

And then it measures the volatility (measured in price change not options activity). 

  • Volatile
  • Quiet

Then we mash them together

  • Bull Volatile
  • Bull Quiet
  • Neutral Volatile
  • Neutral Quiet
  • Bear Quiet
  • Bear Volatile

These are the six different market regimes.

There is a term in Physics called Frame of Reference

A frame of reference is a set of coordinates that can be used to determine positions and velocities of objects in that frame; different frames of reference move relative to one another.

Einstein used Frame of Reference in his Theory of Relativity. 

A Frame of Reference is simply a way to adapt analysis to different environments. 

For example, when you see a car driving down the road at 65 miles per hour/100 kmh, as you are standing watching it go by it looks rather fast to you. 

However if you were sitting inside the car, you would feel as if you were standing still. 

The frame of reference for the pedestrian is different than for the passengers in the car. 

The SQN is a way to get a frame of reference to index against. (Physics lesson done for the day, back to trading!)

There are plenty of ways of going about it, and the technique that I use isn't the best of the best (or is it?), it's the one I use. 

Most traders tend to take each trading day, day by day, trying to nail down a trend day or a mean reverting day for example. But they miss the bigger picture of the regimes, and how important the regime is. 

Or they are always looking at an asset class to be breaking out and racing to catch the first entry in a massive move. 

What if you knew that certain asset classes dominate Neutral regimes but suck at bullish or bearish regimes. 

What if you knew that a certain asset class spends >80% of its time in bull regimes. 

What if you knew that that that precious index you love to short day in and day out, only spent 20% of it's entire life in a bear regime.

And most importantly what if you knew that only .30% of all trading days, the last 20 years was spent in bear volatile. Let me make sure you don't confuse .30% with 30%, that's 0.30% of over 5000+ trading days. 

A couple of things that stand out to me based on asset classes, COMPARED TO EACH OTHER

  • Equities spend the most time in Bull Mode
  • Commodities spend the most time in Neutral Mode
  • Currencies spend the most time in Bear Mode

Overwhelmingly none of these assets spend a lot of time in bear mode.

With this information you can take the asset class that you are trading and find out where to spend the most amount of time


You can focus on one/two market regimes and nail down one strategy that works for most assets in that regime. 

Since all these assets spend most of their time in Neutral or Bull regimes, finding strategies that work in those regimes would be the best use of your time. 

Now since we are talking about the same strategy for two regimes I did some blending of regimes to come up with a Blended Bull Regime (Bull Quiet + Neutrals) and Every Other Regime Blended.

Since I know that a couple of my strategies work best in one OR the other category to help identify where to focus.

I want to spend all my time where the most opportunity is, so I can really take advantage of a 70% win rate.

This doesn't mean that $ES and $GC are going to be the best asset to trade for my strategy, but it does mean that I know where I'm going to spend my time backtesting and where I won't be wasting time otherwise. 

In addition to working with a group of fellow traders going down these rabbit holes and sharing our insights we are constantly improving our strategies, backtesting in teams to build and improve upon our strategies. 

That's a screenshot of last nights work by a group of Lab Members who are collaborating on an intraday strategy. 

And the last few weeks have been beast mode day trading $NQ futures 

Trading by yourself, guessing away at markets is hard. It's way more useful (and fun) to work with a team. 

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