Our market risk indicator warned on 10/10/14 and since that time the market has dropped and recovered in an extremely sharp V formation. The quick move is causing the indicator to whipsaw on a daily basis. It has been moving back and forth between warning and clearing the warning. If the market doesn’t fall sharply between now and Friday I expect the warning to be cleared which will cause a whipsaw hedge signal as discussed in this post. With that said, the picture is still cloudy so we’ll have to wait until week’s end for clarification. As always, I’ll post before the last hour of trading with an official call (and any portfolio allocation changes).

One point on the issue of whipsaws. Please be aware that this indicator is specifically designed to warn of the heightened possibility of quick drops in the market. It has a good record of warning before big declines, but also has a lot of whipsaws. As a result, we use it mainly for a signal to put on an aggressive hedge which benefits from high volatility and rebalancing. It is NOT a good long/short signal. It provides acceptable results as a long/cash signal, but will lag over the long term because it is often late in clearing after small declines.

Look at the chart below and you’ll see good calls before the flash crash in 2010, the steep decline in late 2011, and a small drop in 2012. Also note that in 2010 and 2011 the indicator whipsawed twice before the market finally put in a top. Here’s more information on the indicator that has achart going back to late 2007 where you can see even more whipsaws…just in case I haven’t stressed the point enough.