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Investors can manage the risk of their portfolios by increasing their cash allocation when markets are trending down and increasing their equity allocation when markets are trending up.
To determine the cash allocation, we can look at stocks in the market and find out the percentage of stocks that are in a downtrend. The higher the percentage of stocks in a downtrend, the higher our cash allocation.
During a crisis when most stocks start to enter a downtrend, this strategy will increase its cash allocation to protect the investor's portfolio from large drawdowns. When the market starts to recover, the strategy will gradually switch from cash to equities to take advantage of rising prices during the recovery.
We compare the performance of investing in the S&P 500 using the cash allocation from our fear and greed index against a buy and hold strategy on the S&P 500. The backtest shows that our risked managed portfolio has lower volatility and lower drawdown during a crisis.