Impact of Quantitative Easing on Stock Market Indices
Everyone on the street talks about Quantitative Erasing and that it is messing up the markets, causing inflations, etc. Can we really identify the characteristic change in the S&P that distinctly separate its behaviour from its normal self, or, is that just a myth?
Quantitative Easing is a Form of Loose Monetary Policy
As oppose to viewing QE and QE2 as unqiue incident in history, we can actually check on historical periods where loose monetary policy was in place and how that affect the stock markets.
QE and QE2 are effectively the turbo version of classic loose monetary policy. If we can find something in the historical price data that persist only during such period of time, we can then assume such behaviour would amplify during the current QE period.
Bottom Picking Binary Bet Model
Most traders know simply buying from an oversold condition on the emini S&P does not work.
Seldom did anyone tell you that yes it can work and can work very well if you know that a floor is artificially built for you to bail you out.
Here is the setup of the model.
- 5 minute chart of Emini S&P
- Slow K 20 period 5 smooth
- Go long when it rises from below 20
- Binary bet – either take 3 pts or lose 3 pts
- Exit on close if necessary
Take a look at the results. The red line below is the net profit of the trading model.
Loose Monetary Policy Skewed the Characteristics of the Index Future
The net result of the system presented is bad. But, it shows you that during the last 2 loose monetary policy periods and that now under QE, this concept of buying the dip worked and still works like a charm.
Also notice that the same system does not work in normal condition during 2005 to 2006.
Think of those who thought they have found the holy grail trading system (i.e. buy dip) back in the beginning of 2008 using only data from 2007. When these trading models or setups failed to perform, these individuals would have a very hard time to figure out why everything went wrong.
There is no way anyone can foresee if loose monetary policy will be employed or when QE will really end. The important thing to remember is that when something as important as monetary policy changes, they do have profound impact on the characteristics on many financial instruments. Pay close attention to your trading setups and models to see if your trading results are affected.
One day, it can be your life saver.