Why you Should be Afraid of the V-Shaped Reversal

If you’ve ever wondered what people are talking about when they talk about a V-shaped recovery to a recession, or a V-shaped rally in markets… just take a peek at the price action in stock indices, Crude Oil, Wheat, and to a lesser extent New Zealand and Aussie Dollars. 

SP RussellCrude and WheatNZD AUD
(Disclaimer: Past performance is not necessarily indicative of future results)
All Charts Courtesy: Finviz.com

These types of sharp reversals are kryptonite to your run of the mill systematic trading strategy which uses price momentum such as the big down moves on the left side of the “V” in all of these charts to get into new trades. From there – the trade is simple. If prices keep going down – the trade is likely to be a winner. If there is a reversal, it is likely to be a loser. But here’s some additional detail to consider – if it is a sharp reversal, the trade is likely to be a bigger than usual loser.

One of the long standing “knocks” on systematic trend following strategies is that they often give back open trade profits. But that complaint is usually framed in terms of a profitable trade, something like “you made 10% as the market had an outlier move, then ended up only making 5% as the market slowly retraced and the program waited to get out until the trend as confirmed over”.

The ‘V-shaped’ reversal brings what we call “full stop outs” into play, because of the speed at which the reversion to the mean happened. A typical systematic managed futures program may risk around 0.75% of the account equity on any one trade, yet few trades actually end up losing that much. This is because a typical trend following trade is comprised of both the risk from the entry price and the risk from the market price, meaning most models only need a small amount of time in the desired direction for the moving average of prices to come down/up, thereby reducing the amount of loss (from the entry point).

Here’s a graphical look at the risk over time (as measured from the entry price) for a fictitious trade using a basic trend following model. You can see that the greatest risk to a typical trend following type trade (the bulk of managed futures trades) is right at the outset, where the position is at risk of a sharp reversal and what we call a “full stop out”.

Risk from Entry Price

PS – It’s hard to talk about “V” in our office without the tech guys reminiscing about what they call one of the greatest sci-fi miniseries ever.

PPS – We prefer this shape in coffee much better:

Coffee
(Disclaimer: Past performance is not necessarily indicative of future results)
All Charts Courtesy: Finviz.com

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Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, RCM's own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, RCM's own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.