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Gut wrenching volatility

A volatility in the stock markets is normal. It is a part of it. When looking in the rear mirror and see all those drops we think: “it is all OK and normal.”

But experiencing such volatility in real time is painful and… gut wrenching.

Many people can’t take the pain. I must admit, I too feel sick to the bottom of my stomach when my own cash is involved in this market which is eating it up. But I keep saying myself: volatility is normal, volatility happens. It must happen.

And when it happens we panic. And sell and run away.

I have experienced investors in our group who couldn’t take it and bailed out.

For the last 7 days the stock market was in a selling mode. First few days were slow and markets rallied at the end of the trading session. It didn’t recover the losses though, just rallied, creating nice tails. At first it looked like we had a small dip.

But last two days – Wednesday, October 10, the market lost the support and tanked hard. It lost 94 point or -3.36%!! On Thursday, October 11th the market again looked like it might recover. In the afternoon, selling sped up and S&P lost another -2.06% !!

S&P 500 correction

At first, I expected the market to honor a support at 2875, which was January high, the market smashed below. I expected it to honor another support at 2801 level. It didn’t hold.

S&P 500 correction

The 50% Fibonacci retracement at 2745. The market breached that level today.

S&P 500 correction

The selling was sharp and ugly.

What to do when the market sells off like this?

There are two types of volatility out there: volatility to ignore and volatility to respect.

In order to know what to do, an investor needs to step away from day to day charts and look at higher time frames. And doing so today, you will see that we are clearly in a secular bull market.

If you think that this selling is the beginning of a bear market then know that bear markets never happen in two days, bear market sneaks in slowly before it hits hard and it takes for a long time of selling, not just 7 days. Knowing that we are in a long term secular market and knowing that we just saw 7 days of selling will help you determine whether to ignore or respect today’s volatility.

As a stock investor, knowing that this is just a retracement, an expected correction, you do nothing! Stay calm, hold your stocks, and buy more shares! This is a gut wrenching volatility for sure but not a roll over to a bear market. Not yet!

As an option trader, it is a bit more complicated. Options are instruments which have limited life time. They expire. You do not want to get caught deep in the money at expiration or be assigned early. Then close the trade or roll it. I prefer rolling it. Roll it far away and sell offsetting calls, or keep selling calls to collect as much premium as possible.

With corrections like this, you want to move your options far away to give the market time to repair and eventually the price will come to your puts and you will be safe again.

The following table shows all corrections since 2009 lows. They happen, they may be ugly, but they eventually recover. Some sooner, some take longer:

S&P 500 correction

Also, note May 2, 2011 to October 4, 2011 drop. The market declined -21.6% during that period of time. By definition, a 20% drop in stock prices indicates the market to be in a bear market!

So, if someone will be telling you that this bull market is the longest bull in history, lasting more than a decade, then that person is ignorant. We had a bear market in 2011. So this bull market is only approximately 7 years old. It still can last another 10 years. With gut wrenching volatility.

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