Last Wednesday was just a warm up. There’s more volatility headed our way.
From the high on Wednesday, to the low on Thursday, the S&P 500 lost 47 points. Now… in the context of the remarkable rally we’ve seen this year, a 47-point loss is not all that bad. But, for investors who were late to the party, and for traders who were piling into the “short volatility” trade, last week’s decline was tough to stomach.
Fortunately for those folks, the market got a dose of Pepto-Bismol with a better-than-expected jobs report on Friday morning. That report sparked a rally that helped the market recover everything it lost on Wednesday and Thursday, push the averages into the green for the week, and boost the increasingly bullish sentiment among traders as we headed into the weekend.
But, I don’t think the selling is over.
I think there’s an outside chance the market is setting up similarly to what happened in late January 2018. Back then, the Volatility Index (VIX) generated a broad stock market buy signal – which lasted for just a couple of days. Then we got a more significant decline – corresponding with a sharp rise in volatility.
Here’s a chart of the VIX along with its Bollinger Bands…
The VIX generates a broad stock market buy signal when it closes above its upper Bollinger Band and then closes back inside the bands. That happened in late January last year. And it happened on Thursday.
Buy signals that occur after a prolonged downtrend tend to mark the start of an intermediate-term rally for stocks, and they tend to last for several weeks. But, buy signals that occur while the market is trading near its highest level for the year, and while the VIX is at a relatively depressed level, tend to last for only a couple of days. Then, we often see the VIX spike higher again while the broad market sells off.
That’s what happened last January. And it looks to me like we’re setting up for something similar to that right now.
There’s no guarantee it’ll play out the same way, of course. But, since no one else is talking about the potential for increased volatility, and everyone seems to be betting on lower volatility, it might be useful to consider an alternate view.
Best regards and good trading,
In today’s mailbag, one subscriber thanks Jeff for a “small” gain…
Thank you, Jeff, for my 70% profit in one day on the May puts that we closed yesterday!
Your email on closing the trade described our profit as small, as I recall, but since I opened the trade late, on May 1 for $1.99, and closed it for $3.39 on May 2, my profit was 70%, in less than 24 hours! Please continue to send us subscribers such “small” gains.
And another subscriber gives their take on Friday’s essay, “Here’s Why You Don’t Look Back on a Trade”…
I agree with all your reasons for not looking back, but I think there is one positive reason for doing so, particularly when you’re in the initial learning stage of trading. In that stage, it is important to study all your actions to see if there is something you missed that would, in the future, enable you to optimize your actions relative to profits.
This is the basis of the “trial and error” approach – analyzing your mistakes in order to improve future actions. However, when doing this it is imperative (but always difficult) to prevent the negatives that you well listed.
Do you think volatility has cooled down, or do you see rocky times ahead? And how are you preparing?
Let us know how you handle market volatility, along with any other trading questions, suggestions, or stories at [email protected].