Issue 17: Risk Parity Breakdown Shocks the Stock Market - Masters in Trading Digest

Risk Parity Breakdown Shocks the Stock Market

Welcome to Issue 017 of Masters in Trading Digest.

In today’s FREE MIT Digest, we share a clever observation from Pablo Lucena.  Pablo is the creator of our EDGE Futures Charting Program, along with the Wall Street Wiretapper.

In Friday’s, Issue 16 of the MIT Digest we discussed Position Management. The information shared on position management is important, so today’s episode includes a fun quiz to test your retention of this information.  

Are you ready? You can find the Quiz below in the MIT Digest.

Good investing,

Jonathan

RISK PARITY BREAKDOWN CAUSES SHOCK TO THE STOCK MARKET

The chart above shows a comparison between two trading instruments:

  • TNX – CBOE 10 Year Treasury Note Yield Index
  • /ES FUTURES – S&P 500 Futures

Notice on the chart (far left) at the beginning of Covid, the /ES Futures sold off considerably, but also the 10 Year Treasury Note Yield sold off as well.

When the 10 Year Treasury Yield sells-off, the yield on 10 Year notes go lower but the price of the asset moves in the opposite direction (higher).

Institutions (Hedge Funds) use ‘Risk Parity’ to trade a balanced portfolio and hedge risk the portfolio manager sees in the market.

A portfolio manager who was long stocks before Covid faced early losses as the stock market fell.  The portfolio manager who held long bonds was able to profit on the price appreciation of bonds as the yield dropped quickly.

The next chart shows the exact same thing as the first, but instead of charting the S&P 500 Futures against the 10yr yield, in this chart we are now comparing the /ES Futures against the 10 year future contract, /ZN.

The /ZN reflects the price of the note.  If we go back to the beginning of Covid, notice how the S&P 500 Futures collapsed, while almost simultaneously the price of the /ZN goes higher (red line).

Bond prices and Equity prices moving in the opposite direction is what ‘normally’ happens in the market.  This makes sense the more you study modern portfolio hedging.

BUT, what if this correlation breaks down? 

That’s the topic Pablo Lucena discussed with our coaching students this past Friday.  Pablo makes a strong point that when Bonds and Equities breakdown, volatility spikes.

This is an excellent discussion on portfolio management and we encourage each of you to go through this valuable 10-minute video.

Watch Pablo’s Risk Parity Video

Leave your comments (questions) in the Youtube video, we will reply to each one of you.

MONDAY FUN OPTIONS QUIZ

Did you complete your homework?

Great!

Here is our quiz for today! 

Enjoy!

What Else You Need to Know

Have you seen our new blog?

My first post was Self Reflection – My Journey with NFTs ad Ethereum

Pablo Lucena wrote a phenomenal piece on Position Management:  Demystifying Synthetics

Long-term Masters in Trading client Stacy Brovitz shares an important take on the benefits of paper-trading in Why an Advanced Trader Paper Trades.

Check these out, and many others at Masters in Trading Insights

FINAL THOUGHTS

WHAT TO EXPECT IN THE NEXT MIT DIGEST

The next issue of the MIT Digest will be released Wednesday, January 26th, 2022.

We are getting into the earnings season.

This Wednesday we will discuss earnings expectations for the first quarter of 2022.

Keep your feedback coming into support@mastersintrading.com.  We’re excited to share your feedback along with fantastic suggestions for upcoming issues.

Until then, trade smart and always manage your tail-risk.

Thanks for reading,
Jonathan Rose

Get Masters in Trading Digest FREE!

Want FREE actionable trading tips and strategies like the ones you see here 3 times per week?

We're now accepting sign-ups, FREE for a limited time. Register below to join the Digest.





 






Unsubscribe at any time! Your email address will be used to send you Masters in Trading DIGEST issues.

Masters in Trading Digest - Issue 17

Share this post:

Get MIT Digest!

Want FREE actionable trading tips and strategies like the ones you see here 3 times per week?

We're now accepting sign-ups, FREE for a limited time. Register below to join the Digest.

Unsubscribe at any time! Your email address will be used to send you Masters in Trading DIGEST issues.

Share this post: