August 18, 2011 -Volatility is the lifeblood of active traders. It doesn't matter if the market shoots straight up or drops like a rock; skilled active traders with sound trading strategies who utilize risk management tools, will have opportunities to profit from the moves.
The recent S&P downgrade of U.S. debt and worldwide economic uncertainty have left many long-term investors scratching their heads, but also created an ideal trading environment for savvy market participants with short-term time horizons. The current trading landscape is reminiscent of the heady days of 2008 when huge market swings and sometimes significant profits were gleaned by those who stuck to their game plans and did not let a turbulent market impact their approach to trading. However, it's important to note that buy and hold types and mutual fund sitters can get hit hard on the very playing field that is ideal for active, aggressive short-term traders.
While the actual volatility triggered by the downgrade was measured far less than the volatility during 2008, it was still a welcomed relief for active traders. The VIX or Volatility Index is what market analysts use to measure the volatility of the marketplace. During 2008, the VIX hit an astounding high of 89.5. More than a few volatility traders and funds made huge profits during this time. In comparison, the VIX spiked to a high of 48 in the trading days following the recent downgrade. For some perspective on volatility, the VIX spiked to 49.35 after the 9/11 attacks on New York City, it hit 48.64 during the Asian financial crisis in 1997. The Long Term Capital Management meltdown in 1998 forced the VIX to 49.53 while the Euro debt crisis pushed it to 48.20 in May 2010. Fortunes were made by sophisticated active traders during these times of excessive volatility.
Generally active traders have an opportunity to turn a profit a few ways when volatility surges. Some short stocks when the VIX is rising. Their thinking is that as volatility rises so too does uncertainty which drives many investors to close out their long positions. This selling has a ripple effect and creates opportunities on the short side for short-term traders. Others choose to buy stocks when the VIX becomes overextended. More technical traders tend to watch the daily VIX on a chart while monitoring Bollinger Bands for buy and sell signals based on the movement of the VIX. Lastly, option traders tend to implement different types of spreads and combos to catch the volatility regardless of which way the market is headed.These can be very opportunistic times for an active trader that is disciplined, has proven trading strategies and uses sound risk management techniques.
Copyright 2011 Lightspeed Financial Inc. All rights reserved. Any comments or statements made herein are not an endorsement of any trading strategy or security and are made for informational purposes only.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.