Introduction
Understanding market risk phases is crucial for traders aiming to navigate the complexities of financial markets effectively. Our research at MarketVibe sought to answer a pivotal question: What do historical At-Risk periods have in common, and how can we identify them early? This inquiry is vital as it addresses the common pain point of being caught off-guard by sudden market downturns, enabling traders to make more informed decisions about risk management and portfolio adjustments.
Data & Methodology
To explore this question, we analyzed a wide range of data, including index prices, breadth metrics such as the % Above 50-DMA, A/D Net, and New High–New Low (NH–NL), as well as volatility measures like ATR%. Our study spanned multiple bull and bear cycles, focusing on stress events to capture the dynamics of elevated risk periods. We measured variables such as forward returns, drawdown depth, and the duration of elevated risk. It's important to note that this research is exploratory, with inherent limitations like sample size and regime differences, emphasizing tendencies rather than certainties.
Key Patterns & Findings
Breadth Weakness and Index Highs
One notable pattern observed was that when breadth metrics weakened while indices made marginal new highs, future risk tended to increase. For instance, if the % Above 50-DMA fell below 40% while the index reached new highs, it often signaled a fragile market environment.
Clusters of Elevated CWI Readings
We found that clusters of elevated Crash Warning Index (CWI) readings frequently preceded larger drawdowns. However, not every cluster led to a crash, highlighting the importance of using CWI as a risk condition indicator rather than a precise timing tool.
Volatility and Breadth Interactions
Certain combinations of elevated ATR% and weak breadth were more detrimental than either factor alone. For example, when ATR% exceeded 2% and breadth metrics like A/D Net turned negative, markets often experienced significant volatility.
Case Studies
The 2008 Financial Crisis
During the 2008 financial crisis, the market was in a Warning state for an extended period. Breadth metrics were deteriorating, with the % Above 50-DMA dropping significantly. Volatility spiked, and defensive sectors began to outperform cyclicals. Traders at the time likely felt a mix of anxiety and confusion, as traditional indicators were flashing red. The subsequent market crash validated these signals.
The COVID-19 Pandemic
In early 2020, as the COVID-19 pandemic unfolded, the market exhibited similar patterns. The CWI showed elevated readings, and breadth metrics weakened sharply. Volatility surged, with ATR% reaching unprecedented levels. The rapid market decline that followed was a stark reminder of the importance of monitoring these indicators.
From Research to Product
Our research has significantly influenced the design of MarketVibe's tools. Clusters of elevated risk readings informed the threshold bands and color zones of the CWI, providing clearer visual cues for traders. The interaction between breadth and volatility metrics encouraged us to combine these indicators in our Market Dashboard, rather than relying on a single metric. The Decision Edge Dashboard aggregates Climate, CWI, breadth, and leadership into a coherent snapshot, balancing sensitivity and robustness to avoid overfitting.
Practical Takeaways
- Treat sustained elevated CWI values as a warning about environment fragility, not a precise timing tool.
- Pay attention when breadth weakens while headline indices grind higher.
- Use multi-metric views (Climate + CWI + breadth + volatility) to frame risk posture, not to predict every move.
- Monitor sector leadership shifts, especially when defensives start outperforming cyclicals.
- Consider volatility spikes as potential precursors to market downturns.
Limitations & Responsible Use
While these findings provide valuable insights, they come with limitations. Market structures evolve, and what worked in one era may behave differently in another. Data quality and survivorship bias are concerns, as is the risk of overfitting. Even strong tendencies have exceptions, underscoring the need for robust risk management and position sizing. Traders should use these insights as inputs to their own tested systems, avoiding over-reliance on any single pattern or metric.
If you want to monitor these risk conditions in real time, MarketVibe provides dashboards for CWI, breadth, and Climate at 1marketvibe.com.
Disclaimer: This article is for informational purposes only and should not be considered financial advice. Market conditions can change rapidly, and past performance is not indicative of future results.