A Trader's Thoughts On Recent Market Volatility

 |  Includes: SPY
by: Carlton Chin, CFA
The stock market has dropped swiftly and viciously over the past few days. After the S&P 500 touched 1220 on Tuesday, September 20, 2011, the market dropped to 1130 as of the close on Thursday - before bouncing slightly on Friday. At this level, the S&P is currently down about -7% for the month, -14% for the quarter, and -8% year-to-date.
The turbulence has impacted many other financial markets – including crude oil, precious metals, commodities, currencies and fixed income. In just a few days, crude oil dropped from $90/barrel to $80/barrel. Gold has declined from just above the $1800/ounce level to $1650/ounce.

Commodity prices dropped about -10% over the past few days. Silver had a breathtaking decline of -10% on Thursday, followed by an additional -17% on Friday. Copper, which some analysts follow as an "economic indicator" has decline about -25% from recent highs of near 420 to the 325 level.
Here are a few quick thoughts for these volatile conditions, during these difficult economic times:
  • Don’t try and catch a falling knife. Most good trading systems will minimize risk and “stop losses” from accumulating. You can never tell how far emotions will carry a large market move.
  • When “contagion” spreads, it is sometimes best to step aside and reduce positions because psychology and emotions can also spread – causing markets to move past any "reasonable" level.
  • Some traders and trading strategies may try to take advantage of these market conditions.
  • When "fear" and "panic" hit, anything can happen.
  • Many portfolio managers are reducing positions, so markets become more "correlated" to one another.
  • “Diversification helps until it no longer helps.”
  • Trade down to the level that lets you "sleep at night."
  • From a trader's perspective, once the markets find footing, these "dislocations" may offer opportunities.
And in case you were wondering:
  • Our stock market indicators are currently "overall" bearish.
  • Our short-term indicators have dictated our stock market positions because our other indicators (long-term and intermediate-term) have been neutral.
  • Currently, however, our long-term model has flipped to bearish.
  • In addition, our intermediate-term indicators are currently moderately bearish. Note that a look-ahead at the indicator shows that the oversold indicator may flip to bullish in the near-term.

Disclosure: I am short SPY.

Additional disclosure: Short S&P futures. In stock accounts, long stocks for long-run.