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Lessons from the Volatility Shock of 2008

High volatility is a godsent if you know how trade and invest the markets.

High volatility means beaten down stocks can easily jump 2x to 5x during bear rallies. In some cases 10x or more in one jump alone.

Technique is to buy beaten down stocks using price divergence signals. When they jump - sell 1/2 of the holdings at 2x or more. This makes the other 1/2 holdings basically risk free with extra profit for the effort if it goes more than 2x. Hold the other half as long-term investment and sell at 10x or 20x or even 50x depending on you time-frame.

Dangerous game because those beaten down stocks can easily go bankcrupt.

Not so dangerous while the downturn is still young and companies less likely to go bankcrupt with their cash reserves that can last more than 2 years.

Also, this technique requires considerable knowledge of and experience in technical analysis.

Some of the stocks I traded during the first bounce off July 2008 were ABK, AMR, and JBLU. There were few pickings at that time and I even got crushed by CC and PIR.

During the Oct 2008 meltdown, MS, OMX, ODP among others got crushed so badly even their weak bounce produced more than 2x but timing was extremely hard to execute since the momentum to the downside had dramatically increased with more than 90% chance of further lower lows. I got crushed with SIRI.

The Nov 2008 follow-up sell-off was predictable and a lot easier to anticipate due to the exteme downside momentum that was generated in Oct 2008. GM, F, DRYS, C, BAC, TASR, etc. were beaten down so badly that their reactive rallies proved to be more than 2x. Some even went 5x or more.

Jan to March 2009 major sell-off was the much anticipated final leg to the May to Oct 2008 market meltdown with a target of SnP 600. It did'nt happen since the BKX was already finalizing the last legs of it's run down on the weekly chart.

So, I bought a lot of Financials including C, BAC, XLF, UYG, STT, STI, etc. It proved to be a perfect timing on sector analysis being able to provide the catalyst for a major reactive rally. BKX went up 75% just on the first bounce with C, BAC, UYG jumping up like crazy. I also bought GE which was heavily shorted at that time. It was also almost impossible to ignore the preponderance of extremely bad news at that time regarding solar firms and projections for more dire sell-offs. The news came out after the solar companies have already gone through a prolonged sell-off - meaning, investors have already priced-in the bad news before they got released. SOLR, ESLR, LDK were among those most damaged stocks. They jumped with joy on the first opportunity to do so. There were so many stocks sold off by shell-shocked investors during the Jan to Mar sell-off such as AFFX, AYR, ATPG, CBL, HLX are among others I simply can't buy anymore when I run out of capital. Using margin account was an alternative but with SnP still having a 600 target, it was extremely dangerous using margin account.

Now, why buy such trashy stocks in the first place? Why not simply buy strong and stable companies such as JnJ, MCD, AMZN, WMT, etc?

Trashy companies got hammered so badly due to extreme investor panic. They know very well those companies can easily go bankcrupt so they sold their stocks at any price. What they did not consider is that those companies still have some cash left to last them 6 to 9 months or more before they start considering bankcrupcy proceedings.

Sell half of the holdings at 2x or more and hold the other half as long-term investment. With basically zero cash investment on the other half, it does'nt matter if they go bankcrupt. If the economy recovers, those beaten down stocks will appreciate 5x, 10x, 20x, or more in 3 to 5 years.

Look at JnJ, MCD, AMZN, WMT. Strong and stable companies. How much did they jump since March 2009? 10%, 20%, 30%? How come? They are not volatile stocks, they simply cannot jump 2x or more.

VIX jumping to 89.53 in Oct 2008 generated extreme momentum to the downside.

What happens when extreme momentum is generated?

Stocks kept going down even if the momentum and/or VIX kept on tapering down.

Another major sell-off or capitulation sell-off (with VIX spiking up but lower than 89.53) will be needed to produce the divergence buy signal for stocks. It may take another 5 months to 9 months of bear rally consolidation before this can happen.

Buying beaten down stocks and selling for 2x can become extremely dangerous by that time since many of them will be running out of reserved cash.

Likewise, if the economy finally recovers, even if 7 out of 10 beaten down stocks go bankcrupt; the remaining 3 can jump 10x, 20x or more in 3 to 5 years after that capitulation sell-off thus making up for more than what had been lost in the 7. Skills in stock picking with fundamental analysis will prove very helpful when considering buying beaten down stocks by the time the capitulation sell-off happens late this year or early next year.

Best buys during the capitulation sell-off will be Financials - only if the Financials go higher high while SnP and/or Dow Jones go lower low. BKX went down 8 months ahead of the Dow Jones and SnP. It is expected to recover first before the major indeces which are supposed to suffer more from more extreme consumer spending crunchdown as the unemployment goes higher.

Banks control massive amount of money they borrowed from the government - they can control the government despite the administration's showing macho posturings. Since the US gov't have borrowed trillions from China and other major countries, those countries will also be at the mercy of the US.

Like what they say "Borrow $1 million from the bank and they control you. Borrow $100 million and you control them".

Ironic that the banks are doing the massive borrowings this time around at extremely low interest rates. The government may never lend them hundreds of billions or even trillions if they are not in big trouble as it is.

Banks would never lend individuals and companies money when they got into big trouble.

Told you, the world was never been round.

Also, what happens when inflation starts rearing it's ugly head?

If you can't beat them, join them.

Expect 100% or more price appreciation for strong and stable companies in 3 to 5 years. No worries for bankcrupcy, no rewards commensurate to risk either.