Category: Investing Insight

Investing insight to make you a better investor.

Day vs. Overnight Volatility

Previously, we discussed how overnight volatility is not necessarily the scary boogeyman that it is made out to be. However, what maybe true for the NIFTY may not be true for other indices. For example, commodity stocks could carry larger overnight risks than, say, FMCG stocks.

If you look at the median volatilities of the two indices, commodity stocks have larger close-close volatility than FMCG stocks. However, FMCG stocks have lower volatility in general, so not sure if the differences are meaningful.

What about QQQs (US tech) and XLE (US Energy)?

Most energy related reports are released during US market hours while earnings reports are not. That could explain why XLE relative overnight volatility is lower than QQQ’s? Also, weekend risks averaging less than daily and overnight risks is surprising as well.

Code and charts on github.

Linear Model Momentum

More often than not, simple models outperform complicated ones. Inspired by some recent academic research that showed that linear regressions yielded better momentum performance, we did a quick backtest to check if building a linear model through recent 12 and 1/3/6-month performance and creating a portfolio using its next-month predictions made sense.

Counter-intuitively, a naïve momentum strategy outperformed linear models.

This is not our first run-in with linear regressions. Our Dynamic Linear Model strategy simply regresses prices to a 45* line and ranks them based on goodness of fit.

Most of the time, of all the different ways to skin the cat, the simplest is the best one.

Code on github.

MCX Commodity Volumes

Typically, trend-following systems span multiple asset classes in order to reduce correlations. There could be a case for applying a trend-following system over equities and commodities in India. However, not all commodities trade and activity profiles can be vastly different.

It appears that most of the trading activity at the MCX occurs between 6pm and 9pm.

Not all listed commodities trade…

… and most of the activity centers around silver and natural gas – two of the most volatile commodities.

It maybe worthwhile to add at least some of these tickers into the mix and measure their effect on trend-following portfolios.

Market-cap Deciles and Circuit Limits

Our previous post discussed how liquidity drops exponentially as the market cap gets smaller. This illiquidity also means that a lot of micro-cap stocks spend their time out of the market.

This is a problem for direct equity investors in micro-caps if they actually try to bank the price appreciation they might have seen in the stocks that they own. And a bigger problem for momentum algorithms in the small-cap space.

Index funds in the micro-cap space have yet to go through a test of the liquidity mismatch between allowing redemptions at daily NAV vs. not being able to trade the underlying stocks for days on end.

Bull markets allow us the luxury of coming up with a plan for something that has plenty of historical precedent.