Volatility Trading With The Composite Leading Indicator
FRED:USALOLITONOSTSAM
Leading Indicators OECD: Leading indicators: CLI: Normalised for the United States
The composite leading indicator is produced by the OECD.
It is an index of components that pertain to each country and is considered a leading indicator of near-future economic performance.
The components for the CLI are:
In this piece, we will look specifically at the CLI for the USA. However, I think it will work for most countries ultimately.
I consider you can use the CLI to accurately forecast slowdowns and volatility in US markets and sometimes outright recessions and crashes.
I have overlaid the CLI (the blue waves) with US recessions (red blocks) and added a 20 month SMA to it.
I have also added in dotted orange bands points where CLI takes out its own MA and moves below it which I consider being a "buy vol" signal.
To be clear, these dotted bands are not necessarily recessions, just slowdowns denoted by the composite leading indicator/MA tool. This does not mean however that they are not potentially good volatility trades (as we shall see).
We can see that out of 14 slowdowns and economic recessions. The CLI/MA has a very good success rate if we view it as a "buy" indicator for the VIX.
The buy points denoted by the orange dotted bands are:
As such, you can see that the crossovers between the CLI signal and the MA on a monthly chart usually preceded volatility bull markets, very serious short-term vix spikes and sometimes even outright recessions.
There are a couple of points to bear in mind here.
Signals sometimes appear up to a year before the "event". That's the whole purpose of this indicator. So in other words, you may have to be prepared to hold. As such, ETF decay which is inherent to instruments like UVXY must be factored in. This strategy is therefore more suited to de facto VIX rather than any of it's leveraged ETF variants.
There are a couple of so-called "false positives" with respect to this indicator calling an "event" very far ahead. For instance, in 2005 it gave a "buy signal" for volatility. This isn't necessarily "wrong" per se, because face it, you'd have been dumping your equities and taking on vol nearly at the very top of the market here. As such there is SOMETIMES ample opportunity to "buy n hold n accumulate". That's another reason why leveraged volatility may not always be suitable per se due to the fact of leveraged ETF decay.
On the other hand, there are some short-term opportunities herewhich are denominated in terms of only months. Leveraged products may be more suited to these.
I believe that we must exercise judgement if we are to implement this strategy and to judge the relative position of our entries relative to the market when choosing what instruments to employ to benefit from volatility spikes.
I believe this does demonstrate the validity of using CLI and other macroeconomic indicators for volatility investing.
It is an index of components that pertain to each country and is considered a leading indicator of near-future economic performance.
The components for the CLI are:
- Component Series (Unit) Source
- Work started for dwellings sa (number)
- Net new orders - durable goods sa (USD)
- Share prices: NYSE composite (2015=100)
- Consumer - Confidence indicator sa (normal = 100)
- Weekly hours worked: manufacturing sa (hours)
- Manufacturing - Industrial confidence indicator (% balance)
- Spread of interest rates (% p.a.)
In this piece, we will look specifically at the CLI for the USA. However, I think it will work for most countries ultimately.
I consider you can use the CLI to accurately forecast slowdowns and volatility in US markets and sometimes outright recessions and crashes.
I have overlaid the CLI (the blue waves) with US recessions (red blocks) and added a 20 month SMA to it.
I have also added in dotted orange bands points where CLI takes out its own MA and moves below it which I consider being a "buy vol" signal.
To be clear, these dotted bands are not necessarily recessions, just slowdowns denoted by the composite leading indicator/MA tool. This does not mean however that they are not potentially good volatility trades (as we shall see).
We can see that out of 14 slowdowns and economic recessions. The CLI/MA has a very good success rate if we view it as a "buy" indicator for the VIX.
The buy points denoted by the orange dotted bands are:
- 1st May 1993
- 21st December 1994
- 1st May 1998
- 1st June 2000
-
1st March 2002
- - 1st Feb 2005
- 1st November 2007
- 1st June 2011
- 1st March 2015
- 1st August 2018
As such, you can see that the crossovers between the CLI signal and the MA on a monthly chart usually preceded volatility bull markets, very serious short-term vix spikes and sometimes even outright recessions.
There are a couple of points to bear in mind here.
Signals sometimes appear up to a year before the "event". That's the whole purpose of this indicator. So in other words, you may have to be prepared to hold. As such, ETF decay which is inherent to instruments like UVXY must be factored in. This strategy is therefore more suited to de facto VIX rather than any of it's leveraged ETF variants.
There are a couple of so-called "false positives" with respect to this indicator calling an "event" very far ahead. For instance, in 2005 it gave a "buy signal" for volatility. This isn't necessarily "wrong" per se, because face it, you'd have been dumping your equities and taking on vol nearly at the very top of the market here. As such there is SOMETIMES ample opportunity to "buy n hold n accumulate". That's another reason why leveraged volatility may not always be suitable per se due to the fact of leveraged ETF decay.
On the other hand, there are some short-term opportunities herewhich are denominated in terms of only months. Leveraged products may be more suited to these.
I believe that we must exercise judgement if we are to implement this strategy and to judge the relative position of our entries relative to the market when choosing what instruments to employ to benefit from volatility spikes.
I believe this does demonstrate the validity of using CLI and other macroeconomic indicators for volatility investing.
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