Global stock markets are currently experiencing extreme volatility with the S&P 500 dropping almost -8% over the last four days.
Stocks have continued to fall in Asia and Europe this morning and there is no doubt that this shakeout is a serious one, with the potential to continue for some time.As Mohammed El-Erian noted on Friday:
“Prices need to fall a lot more before wary investors get off the sidelines.”
I fully agree with this view. Investors have known for some time that we are due a significant correction and they wont want to enter the market without a firm footing.
As a result, we will not be making the usual stock picks this week. To do so would be foolish given the potential for continued liquidation.
Although we will not be making the usual stock picks, there will be plenty of opportunities for short-term traders this week. If you do decide to short into this market (which I don’t necessarily think is a bad idea) I would hedge with one of the larger cap, defensive names, perhaps a long position in $MCD.
Watching the Fear Index
One of the strategies on the HTBWS course involves going long the S&P 500 future on the close when the CBOE Volatility Index (VIX) is at a two-year high. Exits can be made on the next open or held for up to 30 days. This is a strategy with strong risk:reward and a high win rate that rewards those brave enough to buy during the most scary scenarios. (A similar version was also covered on the trading strategy database Quantpedia).
It currently looks likely that the VIX will close near a two-year high today, giving the potential long signal in the S&P 500. Although the strategy suggests buying at the close and exiting at the next open, I would be cautious at this point as I feel there is more selling to be done and current price action is extremely negative. The market will bounce back at some point, but the question is when to catch the falling knife?
Personally, I am looking for more losses before jumping in with a short-term trade. Although I will analyse price action during today’s session.
On a longer-term horizon, I envisage this volatility continuing and I may not enter into any new stock purchases for some time, perhaps not until October.