Category Archives: Analysis

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How To Deal With Volatility

What Do You Do When Volatility Is High

Volatility is a common feature of the market place and a fact of life that all traders must come to terms with. Volatility in and of itself is nothing more than the movement of the market but can be force in and of itself. Sooner or later volatility will bite you in the ass and that is a simple truth. Volatility c an be either up or down, high or low and does not take trend into consideration. Of course, a trending market can said to be volatile if it is moving at a rapid pace, or if momentum picks up, or if it is affected on a day to day basis by news or fears. The key is knowing how to apply volatility to your trading and what to do when it strikes.

  • Volatility – the basic definition of volatility states that is a statistical measure of movement in an assets price relative to a standard deviation, past price history or both. In layman’s terms it means a measure of how much an asset is moving in relation to how much it has moved in the past. This relation is used an indication of risk, the more volatility the riskier the asset. The assumption being that an asset with higher volatility is more likely to move against you.

The first question to answer is if volatility is high or low? This can be done using a variety of indicators that focus on this metric. Common ones include relative volatility, historic volatility, implied volatility and Bollinger Bands ™. They all use different formulas, and compare price movements in different ways but are all based on comparisons of price movement. I myself like to use Bollinger Bands(tm). These are an envelope trading tool designed by John Bollinger in the 1980’s. The envelopes use a moving average as the central signal line and then the same data is used to create the two bands based on the standard deviation.

Bollinger Bands, Volatility And Trading

Bollinger Bands are a great tool for traders. They are a fantastic tool for measuring market volatility as well as for providing technical clues and entries for traders. The bands give two kinds of signals. The first is the widening and narrowing of the bands. When the bands are narrow volatility is low and when they are wide volatility is high. As a trader you can use these signals as indications of when you may or may not want to trade a specific asset.

The second kind of signal, and those that are more useful as a short term trader, is price action. There are some generally accepted rules for using price action along with Bollinger Bands ™. The thing to remember is that these signals do not take trend or conditions into account so you will probably need to use some other trend identifying analysis as well.

How It Works 

The bands provide a target, or limit, to how much movement to expect. They represent an extreme of price. When prices reach the upper level the market is extremely bullish, when they reach the lower level they are extremely bearish. You can use these extremes for entries. If the bands are narrow, and prices move up to touch or cross either band it is likely that prices will continue to move in that direction into the near future. If prices move outside the band it is particularly strong signal.

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The moving average is also a good place to take signals. If prices moves from one extreme to the other you can take a signal on a crossover. You can also use it for support or resistance. If prices are moving from one band to the moving average and do not cross you can assume they will move back to the other band. In order to get the best signals, and to weed out the falsies, you really need to use support/resistance, trend and momentum to help confirm them.

So, What To Do When Volatility Is High? 

If you are a risk averse trader you may want to take a step back and wait for things to calm down. If you are quick and savvy enough you can use it as an opportunity for profits. Volatility means the market is moving and movement is what we want as traders. More movement means more chances for profits, you just need to be quick to get them.

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Fundamentals Drive My Trading

I began trading with the idea of using pure technical analysis. The basic tenets of TA, that all things are known by the market or will be known, and all that knowledge is represented in the charts, was a big draw for me. TA broke trading down to simple price action, technical indicators, candle charts and I was enthralled.

However, over time, I have also come to love the fundamentals and view them as a primary driver of my trades. If the trend can be likened to the tide in the ocean, the fundamentals are the ocean itself.  The fundamentals lay the foundation for the house to be built on, they prime the canvass so that the master can create a painting and are the waters from which the market tide will flow.

My description may sound esoteric and philosophical but its true. Imagine a foundation being laid for a new building. As more and more details about that foundation become apparent you get a feel for what the building is going to be. Each brick of the building is important, and adds to the whole, but on an individual basis means very little in terms of what the building will look like. The foundation, the fundamental basis the building is built on, gives the building its character. Is it a house, an apartment building, an office? Once you get a feel for what the building is going to be you can start to make educated guesses, speculations, about what it will look like, how many rooms it will have and when it might be finished. The same is true for the financial markets. When you have a grip on what the fundamentals are you can make better speculations on where the markets are going.

What Is Fundamental Analysis

In terms of trading, fundamentals can refer to a couple of different things, depending on which market you are talking about.  Sometimes there is more than one fundamental driver of an asset, sometimes those drivers are in line with each other and other times not. For a stock fundamentals can include the state of the economy, the health of the business, revenue, product pipeline, consumer sentiment, inflation and other economic indicators. For a commodity supply and demand is the biggest fundamental driver although economic conditions have a lot of affect as well. These factors are used to determine if an asset is under, over or fairly priced.

Fundamental analysis also ties into the greater market cycle. The economy cycles between growth and recession and those cycles drive market values. GDP, Gross Domestic Product, is one factor that can be followed as an indicator of the greater market cycle. This is the sum of the output of a region, a country or the world.  Rising GDP, expanding or contracting GDP growth and expectations for growth/decline can affect prices from the near to the long term.

Another thing to consider is how fundamentals affect individual assets. A bullish economy may be good for stocks but it is not good gold and can be both good and bad for oil. Rising GDP and rising GDP expectations are closely associated with a rising stock market. Rising GDP is also associated with rising currency value. When a country is doing well its money becomes stronger.

Within the GDP data, which is usually released on a quarterly basis with monthly revisions, are other fundamental economic drivers of the market. These shorter term data points are drivers of shorter term trends within the greater market cycle. Employment and jobs are perhaps my favorite but there are numerous gauges of inflation, manufacturing, housing  and the consumer that must also be included. Each of these gives a different view of the underlying economic conditions and has the power to move the market

How I Trade The Fundamentals

I like to keep abreast of the economics and the current data so I have a grip on what’s going on, a view of the foundations so to speak. I let the data come and the market do it’s thing. I don’t use any one data point as a trigger other than what the market tells me to do. I have a an understanding of the fundamental conditions but I still let the technicals dictate my trades. A rising tide of fundamentals will show itself in the charts in the form of an uptrend or bull market. As the fundamental picture unfolds there will be catalysts for rallies and corrections and all will be present in the chart as a signal in one form or another. When the technicals and the fundamentals agree, and the signals are in line I make a trade.

My approach to fundamental trading is exactly the same as technical. When the fundamental trends are up, I trade up, when the fundamental trends are down I trade down.  The technicals provide my signals, when they agree with my fundamental look I know I can make a good trade with confidence.

 

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Anatomy Of A Secular Bull Market

I have some pretty strong ideas about the current market environment. In fact, I think we are in the early stages of a secular bull market and can expect to see the markets continue to rise over the next 15-20 years. Seriously. This does not mean they are going straight up, far from it. But what I mean is that over the long term, with periodic corrections, consolidations and pullback, the markets are only going to go higher. I have demographic and technical analysis to back up my views but more of that in just a bit.

First, what is a secular bull market? This is a long and protracted period of economic growth that results in higher values for property, equities and other investments. This is because there are more buyers in the market than sellers. The reverse is true for a secular bear market.

  • Secular Trend – A secular trend is one that last for a long period of time, usually 5-25 years. The secular trend is the primary market trend and the strongest in terms of trend analysis.

Demographics Of The Secular Trend

It all comes down to demographics, people, to understand the secular trend. This story starts with the Baby Boomers, the largest segment of U.S. population. This generation was taught by their parents to save money, they understood the value of a dollar because it was made of silver and the environment for business was great in the post-war economy. Over time the Boomers built up portfolios of stocks, commodities and real estate as they were taught and advised by their money managers. The economy boomed during this time and America grew.

The next generation, my generation, was much smaller. For some reason the Baby Boom of the 50’s and 60’s was followed by a baby bust in the 70’s and early 80’s. As a generation we grew up with conflicting values. On the one hand we were told to save and invest by our parents, told to buy and consume by the t.v. and media and to “dam the man” by popular culture. Needless to say it was a fun time but not a time in which we, as a generation, were preparing for the future.

2010populationbyageYou may by now see where I am heading. The preceding generation was large, were savers and held a lot of what are termed “more risky” assets such as stocks and real estate. The following generation  was smaller and characterized by non-saving consumerism. When the Baby Boomers reached retirement age beginning in the early part of 2000’s they began to sell off their investments in preparation for retirement. The bad thing for them is that there are more of them than there are of us (70-80’s kids, Generation X-r’s) making a market environment where there are more sellers than buyers, a secular bear market. This is why the markets ultimately trended sideways from the 2000 until 2013. There are other things to keep in mind but demographics have the most to do with it. For example the Tech Bubble of the nineties and the market crash of 2008.

The Bull Is Back

I think it is easy to see how demographics affects the secular trend.  So, what does this mean now?  Well, after Gen X comes Gen Y and then the Millenials.  These two groups are larger than Gen X and make up a significantly large portion of the population. I understand that they are having a hard time with jobs at this time but we are making progress. Economic trends are up and so long as this is true the youngest and largest part of our population will continue to strengthen and invest in their and our futures. Remember, as the Millenials come on line in terms of jobs, business, investment and etc they are becoming the net force in the markets.

 The Technical Secular Picture

Looking at a chart of the Dow Jones Industrials or S&P 500 there is a technical argument for the secular bull market as well. The tech driven bull market that ended in the 1999-2000 Tech Bubble was the official end of the previous secular bull market and the beginning of the secular bear market which reigned from that time period until 2013. It is easy to see how the highs set in 2000 are the top of the range and held the U.S. markets in a sideways trend for roughly 14 years.

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During those 14 years there are some key time periods that coincide with the demographic analysis. First, in 2000 the Baby Boomers had begun to turn 60. Not all planned to retire at that time but enough did, and enough were planning to retire soon, to shift the tides in the favor of sellers and begin the secular bear market. Then, when the market was hitting bottom in 2003 the Gen X’er’s were turning 30 and taking charge of their lives. That, and a hot housing market, helped the markets to recover until 2008. At that time Boomers who had been forced to put off retirement stepped back in as sellers, popping the housing bubble and starting the global financial crisis.

The market hit bottom again in 2009 and has made a nice recovery since then. The current recovery, as was the previous, was orchestrated through QE, bail outs and financial manipulation but it has taken hold. Economic policies were a band-aid patch on the markets until the population could mature enough to bear up the burden of the Baby Boomers and still function strongly. The Gen X-er’s couldn’t do it alone, it took their younger brothers and sisters, and even their own kids in some cases, to lend a hand.

With that in mind there are some targets we can apply to the S&P 500. For one, the height of the secular bear is 750. It is reasonable to assume, using standard technical analysis, that the new secular bull would move up past the top of the range by at least that much before a major correction could be expected. This likely won’t happen in a straight line, will come with plenty of bumps and could take a year(s).