Glossary of Terms
The fair value for any FX cross or equity index given the overall macroeconomic environment. Our models capture a wide range of macro fundamentals – economic growth, inflation expectations, whether credit conditions are easy or tight, whether markets are in a “risk on” or “risk off” mood. Model value tells us where any security should be priced given everything that is going on.
How confident we are in that model value. The higher the number the better! But, as a rule-of-thumb, 65% model confidence is the tipping point. North of 65% means the macro environment is critical. Any valuation signals therefore carry strong weight. When model confidence dips below 65%, we deem that security to be “out of regime” – our model is not doing a good job of explaining the price, something other than macro is driving it.
Markets typically move in regimes. Running scared of inflation? Worried about Central Banks tightening monetary policy? A change of government around elections and possible new set of policies? Regimes are essentially the story of the day, the narrative that markets assign to price action. When that story changes – ‘regime shift’ in market speak – the old trades that were making money need to be re-considered. There’s a new story (set of positions) in town.
Fair Value Gap
(FVG) The difference between our model fair value and where the price currently is. A positive Fair Value Gap means the security is rich to model. A negative FVG means that it’s cheap. The bigger the FVG, the richer or cheaper the current level is. In other words, there’s a bigger dislocation, and therefore better entry level for the trades you decide make sense.
I see a fx cross or equity index is rich or cheap versus model. I think I’d like to trade it. But, it would be nice to know if this kind of signal has happened before. And, if so, how successful was it? Back-tests are fancy jargon to describe a simulated history. When EURUSD has been this cheap to macro fair value before, has it been a good buy-the-dip signal? I see SPY is rich to model – has this level of richness been a good level to sell in the past? Back-tests have a clear set of rules – when you enter a trade, where you exit etc - which then shows the success rate for any signal.
Simply the percentage of trades in your back-test that have made money. Any number below 50% means you’ve lost more times than you’ve won. A 50% hit rate is effectively the same as flipping a coin. Over 50% and the balance of probabilities say you’ll make money.
Macro factors / drivers
At any point in time, your trade may be driven by different things. Sometimes it’s economic data; another times it’s Central Banks and changes in their policy stance. Quite often it’s not macro but about politics or big flows (think corporate buybacks or huge funds with lots of money to put to work). But when it is about macro you want to know what’s key. Is USDJPY rallying because markets are in “risk on” mode and the safe haven Yen is for sale? Or because the Fed are deemed more hawkish than the BoJ and will raise interest rates more aggressively? We call these drivers or factors: market jargon that’s basically a way of saying what’s moving your position.
We’ll try not to use this one very much, but it is part of our process. Standard deviation is simply the mathematical term that measures how close together a data set is. It’s how far anything is from the average (the mean). So a large standard deviation number means the data is quite spread out relative to average. A small number means the data is relatively concentrated. In financial markets, on those scary days when there are wild prince swings it’s common to hear phrases such as “that was a 2.5 standard deviation event!” Translation – it doesn’t happen very often!
This simply measures standard deviations. A positive (negative) z-score means that number is higher (lower) than average. The bigger the positive (negative) the bigger the deviation from average.
A custom tool we’ve built that uses our model confidence numbers (see above). When macro is doing a really good job of explaining price moves, the Qi Vol Indicator is low. When macro cannot explain why markets are moving our Vol Indicator rises. When it rises sharply (defined as a 20point increase over 1 month) we’re on alert for markets to go all “risk off”. Our Vol Indicator has a good track record of pre-empting spikes in VIX, the market’s most widely watched “fear gauge”.
Real Time Notifications and Alerts. EyeQ uses sister company’s Qi “market brain” to extract signals in financial markets. By mathematically breaking down key relationships between the macro environment and the markets you trade, EyeQ highlights key opportunities and risks. RETINA is simply the tool that allows clients to get signals on what they trade pushed to them. It feeds your pipeline of chosen investment ideas. Tailored trade ideas, seamlessly delivered.
EyeQ’s signals takes several forms. The Fair Value Gap (FVG) mentioned above is critical in quickly identifying any dislocation between current market price and macro model value. The divergence signal simply identifies when that dislocation has continued for the last 10 days. Our work suggests 10 days can be the point where the difference between market pricing and macro reality has started to become stretched, and often starts to re-converge.
That 10 day period for a divergence signal is the result of testing EyeQ signals across all asset classes. But averages can be misleading. Some periods of divergence could be shorter, some episodes longer. The inflection signal waits for both model value and market price to turn together. After 3 days of both turning up (down), a bullish (bearish) inflection signal is triggered. It is shorter because RETINA is trying to find that sweet spot – don’t jump into a trade too soon, but early enough to capture the new up or down trend.