A few months ago, I mentioned the need to begin reducing market exposure while volatility in the markets was low. This recommendation was due to a higher risk of volatility returning to the markets as evidenced by the (VIX) reaching levels not seen since 2006. I further mentioned that there may be a correction between 8 and 15% over the ensuing months with a peak in volatility occurring sometime throughout September and October. Although we have experienced an increase in volatility, we have not witnessed the more ominous market decline nearing 15%. Although I am prepared to admit that I may have been a bit aggressive about the lower end of the range, October is far from over and this is a perfect opportunity to explain where we are, what the current risks are and how to prepare for the next lower-risk entry point.
Risk was present in the market back in August of this year, and only now are we beginning to see some of the symptoms or evidence of said risk. Mr. Market has a strange way of attempting to fool the greatest number of people at the most inopportune moments. Now that we can see the results of built up market risk and low market volatility, it is evident that the storm is here. This is now an opportunity to begin watching for a near-term low, coupled with significantly higher volatility, high volume, and a subsequent reversal. Add 1-2 follow through days and we have evidence for a lower-risk entry point. The problem is we won't know it until we see it or in other words, there is no way for me to tell you the day or the hour this will occur. Despite our inability to predict, I have developed a proprietary tool that can help us measure risk, and I will explain how to use the tool effectively.
I am a firm believer that many things will return to some sort of mean over time. When looking at the markets and risk, I prefer to view the ebbs and flows as ocean tides. When the tide comes in, per my methodology, risk is higher. Conversely, when the tide flows out, risk is lower. Although I cannot measure exactly when a correction or bounce will occur, I can tell you when there is more or less inherent risk in the market. I can also examine whether the tide has come in further than normal, (presenting greater risk) or gone out further than normal (providing us with rare lower-risk entry points).
More specifically, on the chart above, when risk rises above 20, it is time to begin trimming losers, taking some gains from winners in your portfolio and reviewing the types of positions you feel comfortable holding when things get ugly. If you're more of a long-term asset allocation investor, look at re-balancing your portfolio by shifting equity gains to other less correlated asset classes. You may also consider hedging strategies like selling calls, purchasing puts, or stop limit orders to try to mitigate risk.
When readings get below -20, hopefully you will have already identified your buy list of favorite mutual funds, equities, ETFs etc. because once you identify that high volume, high volatility, downside trading day coupled with a strong reversal and 1-2 days' follow through, you will now begin purchasing. Behind the scenes, you will be purchasing at prices that under normal rational conditions, investors would not be willing to sell for but once emotion is brought to the table and when others are panic selling the rules of logic are usually tossed out the window. It's like comparing an orderly fire drill to what really happens when there is a fire.
Those historical or even hysterical moments are like gems to the well trained and experienced money manager who is looking to buy but these events are rare. Seeing as the ideal buying opportunities do not present themselves very often, as evidenced by the fact that not every correction gets to -20 or lower on my risk measurement tool, there is a little more to discuss. Most purchases are actually made by identifying market reversals between the -10 and 0 levels on my diagram. I will continue to purchase some positions between 0 and 10 and rarely ever purchase anything above 10.
To sum things up, we are now in the middle of the storm and we are identifying the positions we want to own. The next step is to simply wait and watch for volatility to climax, let panic set in and then wait patiently for the market reversal and follow through. Bear in mind that it is never easy to make these types of purchases but with experience, discipline and knowledge on your side you may find that it is a rewarding and methodical way to overcome the emotional aspects of investing.
The information contained in this report or information provided does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered reliable, but we do not guarantee that the foregoing material is accurate or complete. Expressions of opinion are as of this date and are subject to change without notice. This information is not intended as a solicitation of an offer to buy or sell any security referred herein. Past performance may not be indicative of future result. No buy or sell orders may be given using the email, please call the above number to contact your Advisor. Christopher DeMaria is registered with and securities offered through Kovack Securities, Inc. Member FINRA/SIPC. 6451 N. Federal Highway, Ste 1201, Fort Lauderdale, FL 33308 (954) 782-4771. Investment Advisory services are offered through Kovack Advisors, Inc. DeMaria Financial Services is not affiliated with Kovack Securities, Inc. or Kovack Advisors, Inc.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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