Omori Law Recovery Phases

What is the Omori Law?
Originally a seismological model, the Omori Law describes how earthquake aftershocks decay over time. It follows a power law relationship: the frequency of aftershocks decreases roughly proportionally to 1/(t+c)^p, where:

t = time since the main shock
c = time offset constant
p = power law exponent (typically around 1.0)

Application to the markets
Financial markets experience "aftershocks" similar to earthquakes:

• Market Crashes as Main Shocks: Major market declines (crashes) represent the initial shock event.
  
• Volatility Decay: After a crash, market volatility typically declines following a power law pattern rather than a linear or exponential one.
  
• Behavioral Components: The decay pattern reflects collective market psychology - initial panic gives way to uncertainty, then stabilization, and finally normalization.
  

The Four Recovery Phases
The Omori decay pattern in markets can be divided into distinct phases:

• Acute Phase: Immediately after the crash, characterized by extreme volatility, panic selling, and sharp reversals. Trading is hazardous.
  
• Reaction Phase: Volatility begins decreasing, but markets test previous levels. False rallies and retests of lows are common.
  
• Repair Phase: Structure returns to the market. Volatility approaches normal levels, and traditional technical analysis becomes more reliable.
  
• Recovery Phase: The final stage where market behavior normalizes completely. The impact of the original shock has fully decayed.
  

Why It Matters for Traders
Understanding where the market stands in this recovery cycle provides valuable context:

• Risk Management: Adjust position sizing based on the current phase
  
• Strategy Selection: Different strategies work in different phases
  
• Psychological Preparation: Know what to expect based on the phase
  
• Time Horizon Guidance: Each phase suggests appropriate time frames for trading