Identifying Market Regimes

Overview

Expert Identified

Expert Identified regimes are regimes that a trader or other market expert has indentified. Typically this means that the expert has indentified periods in the past and assigned a label to each period. Once this has been, an algorithm can be designed to try to identify the expert assigned labels from other measurable market information. This is an example of supervised learning.

Market Indicators

Another common way to identify a market regime is to associate a set of market indicators with each regime. A simple example of this was the identification of elevated levels of the TED spread with market stress, and hence the risk off trade.

Market Indices

Market indices are often also used to indicate market regimes. As an example, when the broader equity indices are in an uptrend, it is often assumed that the market is in a risk seeking (risk on) trade. When the broader equity indices between to correct or trend down, it assumed that the market is in a risk averse mood. Other indices such as commody indices or FX carry trade indices may also indicate market risk seeking/aversion.

The existence of multiply indices that could indicate market attitudes toward risk means that one can build a composite index as a risk indicator.