The Trader is dead, long live the Trader. This is my official proclamation now that this Bear market has finally proven to us all that it is futile to trade in this market. Technical Analysis, economic reports, historical data - they all have little to no meaning while volatility is sitting above recent historical highs.
Just think about it. In the past couple of years we've had market ups and downs, where sentiment indicators like the Volatility Index and the Put-Call ratio peaked above certain levels we considered watershed events. We called it capitulation. And it was pretty well defined and predictable. Although in retrospect, we thought the world was caving in.
After a strong downtrend, there would be a day when the market would open on a relatively significant gap down. And from the gap down level, the selling might continue for a few hours, and the Volatility Index (VIX, or Fear Index) would rise to the mid 30s or so. The Put-call ratio would peak somewhere between 1.6 to 1.8, and the advance decline line would be dismal, with decliners trouncing advancers three to one, sometimes four to one.
To us pedestrian investors it seemed as though the sky was falling. Then around mid-session, after one final plunge down, there would be a sea change, the proverbial straw that broke the camel's back. And the markets would suddenly rise, and rise sharply, all the way into the close. The VIX would plummet, the Put-Call ratio would drop to under 1.0, and most importantly, the advance decline line would reverse hard, across all the indexes. And we would end the day with advancers totally flipping the stage, trouncing decliners by three or four to one.
On the daily charts we would see the telltale bullish hammer on all the indexes and most equities, especially the leaders, and a huge black candle on the VIX. A bullish rally would ensue the days following that event. That is what we thought to call Capitulation.
But these days we're experiencing a whole new level of market behavior. With this Bear, we've had all the worst parts of Capitulation, and a couple of times the market started to rally. But each and every time it has been cut short, never getting beyond a couple of days. And it's been that way ever since the VIX got above 45. It seems that 45 is the point of Market Entropy. Above 45 and we enter disorder, unpredictability, chaos.
And it is in this state, this twilight zone, that the investor and trader are as good as dead, because none of the traditional weapons in our war chest work. They have no value. In fact, they distract, degrade and ultimately destroy our primary goal of preserving capital, by presenting temporary illusions that what we are doing makes sense. And why not, it's worked in the past?
Well, it's not working now. And it won't work while volatility is above 45.Why is this so? Why are investors and traders fearful of the market? The reason is because of uncertainty. We are uncertain of what the market will do, how it will react to stimuli, not only from day to day, but from week to week, for the next several months or even years. The effects of this Bear market are only starting to impact us, and that's the scary part. Just look at where we are…
The investment banking industry has collapsed, the mortgage industry has collapsed, intra-bank lending is anemic at best, consumer lending has halted. Layoffs are starting to mount, as unemployment has reached nearly 7%, and many think double digits are in our future. The U.S. auto industry is insolvent, commodities, including oil have lost 70% of their value in just a few short months. And it's not just us, the entire global market place is in similar disarray.
So, how did we get here? I think most would agree we got here because of our insatiable appetite for material things, whether we could afford them or not. That's right, we borrowed our way into this mess. People bought houses they couldn't afford, and then using their credit cards, they filled them with furniture and gadgets they couldn't afford either. And if their credit cards were tapped out, they borrowed on the equity of their homes. And you want to know the most insidious thing of all? Our government's solution to getting us out of this mess is to borrow more. It's friggin crazy!
Alright, enough of that rant. So getting back to the uncertainty principle. Let's look at the last apparent capitulation event this past Thursday and Friday. Thursday had all the signs with a gap down, followed by a rally and a reversal of the advance decline line. Then on Friday we started weak, then reversed with a huge rally going into the close. Now in past markets we would have closed positive and continued the rally. But not here! Instead, with less than 30 minutes to go into the session, we plummeted, losing virtually all the gains from a five hour rally.
Why? Well, for a short time there, things were looking good, with the VIX falling and prices rising, then the uncertainty principle was injected, when Fed Chief Bernanke and Treasury Secretary Paulson went on TV and basically told the world that our initial $700 billion bailout plan was a bunch of crap, and we're gonna try something different. Oh, and by the way, we - he was referring to the United States - really screwed up and we feel ashamed.
WTF!!?? Why do they allow this guy on TV? And why is he saying this stuff while the market is still open? Was this some lame attempt for us to appear as if we're the underdog going into the G-20 summit this weekend? Perhaps by admitting to being total screw-ups, it would limit the flame throwing? So we traded nearly 5% in market cap for less name calling at the G-20? I guess that about sums it up. I hope it was worth it!
Ok, enough of that rant too. But this has got me thinking about the whole credit crisis, and this piece I read early today about how one in seven homeowners are underwater on their mortgages, and how so many people have maxed out on their credit lines with no where to turn should they lose their job. The people that are going to fare best, assuming they don't lose their jobs, are those that have been frugal with their credit, and pay cash for things.
And then that got me to thinking about the type of companies that may have the best chance of getting through this mess, with minimal damage. Companies like Apple (AAPL), that have zero debt and lots of cash. Perhaps that's the key right now as an investor? Start accumulating stock in those companies that have long term prospects, no debt and lot's of cash. But what if the price of companies goes down more, I mean significantly more? Should investors just sit in cash and wait it out, or do we start accumulating and perhaps protect those positions with insurance like reverse ETFs? That seems reasonable.
What if you don't have a lot of cash on hand, like a lot of people after taking such a beating. Then perhaps buying deep in the money leaps are the way to go, and you should straddle that position with puts as insurance, or even better yet, you could make that insurance really cheap by selling calls against the leaps in a Bear Call Spread.
If you don't do options, then another strategy might be to dollar cost average into companies like Apple and offset it with inverse ETFs like the S&P 500 ProShares Ultra Short (SDS). You can buy a smaller quantity because it performs at two times the market. So perhaps for every four shares of AAPL you pick up one share of SDS.
Alright, so maybe the trader isn't dead. Perhaps now is the time to play the market volatility and uncertainty with strategies that are designed just for that.
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This article has 4 comments:
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fatcat
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485 Comments
Nov 17 04:16 AM-
mollytjm
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323 Comments
Nov 17 11:18 AMat today's prices, they're a great bargain. i think the holiday sales will show evidence that pent up demand is still very high for it's products. So it's a really, really good 'buy and hold' stock.
i don't know why the Fed bothers to make any statements. They should just try to fix the mess and keep quiet unless they have something good to tell us:)
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Jake2
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249 Comments
My Website
Nov 17 01:21 PM-
jegan ;-)
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764 Comments
Nov 17 01:53 PMjegan