Are we having fun yet? My guess is that anyone trying to deal with the recent volatility in the stock market using anything resembling traditional indicators will undoubtedly answer the question with a resounding, “No!”
Let’s see; over the last eleven trading sessions stocks (as measured by the S&P 500) took a three-day nosedive of about -4%, rallied back +2% over the next two days, then dove again, bounced, dove back to the lows, and then are bouncing again on Tuesday. Ughh.
As everybody knows, the recent bout of bipolar disorder is being driven by several things including the situation in Libya, crude’s rude rise, the fear that the oil spike will negatively impact the global recovery, and the momentum trade.
But most of all, the day-to-day trading activity has been driven by the headlines. One minute stocks are soaring on word that the Libya’s dictator will soon flee the country and the next, well, the indices are threatening to break to new lows – which, to anyone watching the charts (and who isn’t these days?), means that more selling is likely to come in.
Welcome to a news-driven environment. For those investors that had been riding the trend that began on September 1st, the recent volatility has been a wake-up call. For example, that 18-day weighted moving average that had been a golden indicator for most of the past six months would have gotten traders whipsawed five times in the last eleven days – ouch. And a similar story can be found in many popular market indicators.
The bottom line is that when markets are driven by computer programs, which react instantaneously to headlines due to the algorithms coded in, trend following indicators as well as many traditional momentum-oriented indicators become next to useless. In short, traders and computers react swiftly to the headlines without regard to trendlines or something as silly as support or resistance zones.
So, what are traders to do in these up-one-minute and then down-the-next-minute environments? Based on my experience, I feel there are four sound ways to play the game during these volatile periods.
1. Stand Aside. The first way to play a news-driven environment is to simply admit that your crystal ball is in the shop and move to the sidelines. The thinking here is that you can manage the potential downside risk by not taking any. Sure, you may not feel so smart when the short-covering rallies cause stocks to blast higher in response to good news. But at the same time, you will likely feel warm and snuggly on those blustery mornings when the news is bad.
A variation on this theme is to “play smaller” during difficult environments. Just as major league baseball players take less aggressive swings when facing tough pitchers, traders may want to use smaller positions and/or play with lower beta/leverage when the going gets tough.
2. Saddle Up. The next way to play these headline-based markets is to identify the upper and lower bands of the trading range that ultimately develops, and then saddle up and “ride the range.” In English, this means that aggressive traders can attempt to buy each time the market nears the low end of the range and then sell whenever the indices approach the upper reaches. Another popular Wall Street-ism that fits into this category is to “buy the dips and sell the rips.”
3. Place Your Bets. Yet another way to go in these volatile times is to take a stand on the ultimate resolution of the problem at hand. In the current case, if you believe that Gadhafi will eventually get the boot from Libya and that oil prices will fall as a result, you could buy any weakness in the stock market indices. The thinking here is pretty simple. If you remove the threat of an oil-induced economic slowdown from the picture, traders will return their focus to the improving economy. As such, any “dip” in prices provides you with an opportunity to add to your position. If you like this approach, we might also suggest that you keep enough cash on hand to “buy the dips” on three or four occasions.
4. Just Keep On Keepin’ On. Our final entry into ways to deal with a news-driven market environment is to simply follow your system. While not everyone uses a system to manage their exposure to the market, this is one way to help you sleep at night when things get tense. To be sure, no system is perfect. And it is an almost certainty that most systems will stumble from time to time. However, if you understand the approach you are taking with your system and you can deal with the pitfalls of the methodology, then there is really never a good reason to stray too far away from it.
We recognize that none of the options presented here for dealing with news-driven environments are new or earth shattering. However, given that it is easy to lose your way when things get tense, our overall goal here is to help investors understand there are ways to deal with these volatile markets and to remind everyone that these types of environments also come to an end at some point.
S&P 500 - Last 12 Months
US Oil Fund Last 12 Months
Remember, you are in control your email alerts! You can receive alerts for up to 25 free research report alerts including:
-
FLASH Headline Alerts: Get an executive summary of the really important market-moving headlines
-
The “10.0” Report: These are the REAL Best of Breed companies
-
The Insiders Report: Want to know which stocks Corporate Insiders are buying heavily?
-
ETF Leaders Report: Don’t Miss TSP’s Weekly ETF Leaders Report
-
TSP’s Daily TopStock Focus List: It’s Your Own Private Research Department
- The Daily Stock Pick: Our daily stock pick highlights one of our favorite TopStocks that also presents a good entry point at the present time.
To Add or Remove email alerts, simply Login to Your Portfolio and click on Email Alerts
