Oct

27

Stock Market Volatility Cannot Last

By admin

The stock market has recently broken all previous records for volatility, often swinging as much as 10% or more in a single session. This has a lot of people scared as they watch their 401K account balances swing wildly. Papa Riah happens to be an expert in the financial markets (really) and I’m here to tell you that this type of market behavior by it’s very nature just can’t last for any length of time. I have actively traded stocks, currencies, options, and even futures accounts, and have an extensive collection of trading and investment books (all of which I have read and studied). I have even attempted to make a living daytrading at various points in my life, and have authored printed articles on the subject.

Which brings me to the reason that extreme volatility can’t last: It is too easy for daytraders to exploit. Intraday trading is not easy, but extreme volatility makes it easy. Therefore it cannot keep going because all the daytraders will make too much money too easily. This results in a market inefficiency and free markets always close pockets of exploitable inefficiencies rather quickly. Otherwise everybody and their mother in law will get rich daytrading in the stock market – and that just ain’t gonna happen.

Perhaps you are wondering exactly how this is done? Sure, I’m happy to tell you. But first I need to warn you that you are probably too late if you are getting any ideas. Before you get your day trading account set up and are able to start betting on volatility, market conditions are likely to change. It’s also extremely likely that you will discover you have a discipline problem when it comes to closing out losing positions (which is what kills most people who try this).

Traders makes money from extreme volatility by betting on market swings, looking to capture a big one. They are wrong a lot and subsequently take many small losses along the way. However when they finally catch that big swing it more than makes up for all the small losses. With volatility as extreme as it has been lately, traders making these kinds of bets don’t have to wait very long to capture a big swing – it’s been happening almost every day! Easy money, and easy money always dries up fast.

As an example, below is a 3-day chart of the Dow Jones. The red dots are points where the daytrader would be betting on a major swing starting, at a point where it looks like a reversal could be forming. Most of the time this results in a small loss or a small win (if the market turns back and makes a new high or low you get out, if not close your position near the end of the session).

The green dots are the big winning positions. After you have captured a few hundred points you look to get out when another possible reversal starts forming – if not, at the end of the day then. Several of these captured 400 points or more. Although that represents only 5% of the entire Dow, traders are using highly leveraged entities to trade with and enjoy 4 x margin on their account as well. And last week wasn’t even as volatile as prior weeks have been!

dowchart

This simply can’t last because everybody will rush in to start doing this, much like daytraders of the late 90’s who simply bought tech stocks every morning and sold them at the end of the day. They all went bust when market conditions changed, and you can expect that to happen to the most recent breed of daytraders at any time.

So don’t worry about your 401K. If you have less than ten years to retirement you shouldn’t have it all in stocks anyway, and if you have longer to go you should have (at least) most of it in stocks and ignore the market (and your account balance) altogether.

Papa Riah