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COPING WITH VOLATILITY Last Monday morning, the Dow Jones futures were trading above 13,700. Thursday evening, the market traded as low as 13,205 before closing Friday at 13,435. The blue chips traded in a 500-point range in less than one week. Last Monday, crude oil opened at $64 a barrel. By Thursday, it had reached $67.40, representing a $3,400 profit or loss on just one futures contract. (The margin deposit required to trade a crude futures contract is $4,000.) By Friday, it had lost nearly all of those gains. Last Monday, the US Treasury Bond futures were trading around 109. By Friday, as Treasury yields spiked higher, they had bottomed out close to 105, representing a nearly $4,000 per-contract move. The margin deposit required to trade one bond contract is only $1,350. This was almost a 300 percent move based on the margin requirement--in just one week. Last Friday, silver made a $4,000 per-contract move in a 24-hour period. (The margin requirement to trade one contract is currently $4,000.) The markets are certainly volatile right now. How can a trader cope? July Crude Futures A greater than $2,500 per-contract move in just one day last week:
June Mini-Dow Futures
A greater than $2,500 per-contract move within three days last week:
July Silver Futures
First and foremost, keep this in mind during volatile market conditions: Anything can happen. During the last 48 hours of the Enron debacle, the stock was in free fall, collapsing to a new low of $10 a share. (It traded at $90 not all that long before.) I had a client in the metals business who’d partnered with Enron in specialty metals trading. He said he was buying Enron stock at $10, telling me it was a screaming buy because its pipeline assets alone were worth more than $20 a share. This made sense to me, so I bought some there, too. But I also immediately placed a stop loss at $8 and was stopped out in short order. We now know the books were cooked, and that the collapse in what was supposedly the seventh-largest US company wasn’t over until its share price hit zero. So forget logic, and forget what you believe the fundamentals are because, ultimately, the market is always right. As Lord Keynes once said, “The market can remain irrational longer than you can remain solvent.” Seven Rules For Successfully Coping With Volatile Markets The trend is your friend, so don’t fight it. If a market appears to be in free fall, don’t try to bottom pick. If a market appears to be in a trading range, you don’t have to commit to a new position until it declares itself (by breaking out of the range, indicating strength or weakness). If the trend has turned down in a particular stock or commodity, you can consider shorting it, but you shouldn’t be a buyer until there’s solid evidence the trend has turned back up. Use stop loss orders. Stops are defensive protection devices against financial ruin. Remember, you can only control what you can control. You can’t control the markets, but you can control your equity to a major extent via the judicious use of stop loss orders. Reduce your trading size. Adjust your risk-to-reward ratio to a workable level. Buy the strong, and sell the weak. Last week, while many of the financial markets were in collapse, both wheat and cotton actually closed higher. (Therefore, there’s no reason not to be long those particular markets.) Be Selective. Trade less. Lower your exposure. Trade spreads, use options, go to cash, tighten your stop loss orders, employ hit-and-run strategies. There are numerous techniques that can preclude you from sticking your neck fully out during chaotic times. Be unemotional. Never fall in love with any position. No matter how good a stock or commodity has been to you in the past, today is a new day. Take responsibility. You can’t blame the markets, the hedge funds, your broker or the weather. You're responsible for your own result, and only when you acknowledge that fact will you overcome adversity and ultimately triumph.
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