Lessons from 2008 on how to navigate equities in high volatility

Equities 5 minutes to read

Peter Garnry

Head of Equity Strategy

Summary:  In today's equity update we show today's performance of our 'bounce back basket' what we published yesterday as we told investors to prepare for a reversal in equities. With volatility to stay for a while equities will exhibit a lot of mean-reversion. We show how well mean-reversion strategies performed in 2008 and highlight how investors can construct mean-reversion strategies.


One thing is our ‘bounce back basket’ but what can investors and traders learn from the 2008 trading environment to navigate the current environment? With the VIX Index close to 50 equity markets remain in an extreme volatile environment and historically this has meant more volatility (also as the volatility clustering effect) and returns skewed to the downside.

Source: Bloomberg

But even more important high volatility often fuels mean reversion in equities which means that large down days are followed by large up days just as we are observing over the past two trading sessions. In low volatility markets momentum dominates and everything in between has less structure. Mean reversion is structurally driven by volatility and provides investors with an opportunity to become more tactically. In fact we would argue that as volatility increases investors should be less long-term and more short-term. By applying mean reversion tactics investors can add a vital return stream to the portfolio. But how should mean reversion be implemented?

There are several ways. The simple one is to short the stocks that did the best yesterday and buy the stocks that did the worst. As some sectors often lead the gains and declines one should consider not shorting and buying from the same sector. Another way to structure mean reversion is using technical indicators such as Bollinger Bands and RSI selling and buying when these indicators have high and low values respectively. The idea in mean reversion strategies to keep the volatility low is to both buy and sell which is best done on Saxo’s trading platforms through CFDs.

Source: FactorResearch.com

As the plot from FactorResearch shows mean-reversion was a key strategy to any portfolio during 2008. Evidence also suggest that mean-reversion strategies work best when the VIX Index is above the 22 level which is considered to be the long-term equilibrium in the volatility term structure (forward curve). As the oil price war between Russia and Saudi Arabia combined with COVID-19 will likely fuel elevated volatility for some time we will begin regularly to publish inspirational lists to help investors construct these mean-reversion strategies.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-hk/legal/disclaimer/saxo-disclaimer)

Saxo Capital Markets HK is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo Capital Markets HK Limited holds a Type 1 Regulated Activity (Dealing in securities); Type 2 Regulated Activity (Dealing in Futures Contract) and Type 3 Regulated Activity (Leveraged foreign exchange trading) licenses (CE No. AVD061). Registered address: Rooms 2001-02, 20/F York House, The Landmark, 15 Queen's Road Central, Hong Kong

By clicking on certain links on this site, you are aware and agree to leave the website of Saxo Capital Markets, proceed on to the linked site managed by Saxo Group and where you will be subject to the terms of that linked site.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

Please note that the information on this site and any product and services we offer are not targeted at investors residing in the United States and Japan, and are not intended for distribution to, or use by any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation. Please click here to view our full disclaimer.