Hello Rookie Bloggers, we are back with another edition of the rookie blog. We have had a few down days in the market recently and this has got some folks feeling the heat! The markets can be scary when they do things that we are not really prepared for. There are a few reasons that we seem unprepared for what the markets do.
First, is the belief that the market is this crazy wild untamed beast that can only be harnessed for short periods of time and it seems this way because we see increases and decreases in volatility all the time and therefore it seems like there is no rationality for the moves it makes. This is completely understandable from a human perspective as we are logic-based beings that like to fit things into categories even if we are the ones making up the categories based more on our personal experience than that of the universe itself.
We also can be unprepared for what the market does because of our emotional states and biases. The emotional states that most refer to are fear and greed and those are definitely two of the big ones but I think there is one more emotional state that gets folks into as much or more trouble than fear and greed and that is hope. They say “hope springs eternal”, I don’t really know what that means so I had to google it. What I found was that this phrase comes from a man named Alexander Pope and he was speaking about man and his tendencies. Hope springs eternal in a nutshell means that man hopes even in the face of great adversity. In life I believe this to be a good thing…the old keep going attitude so that one can overcome lives many obstacles. However, in trading, hoping can be very detrimental to ones trading account. Just like fear and greed can destroy your account, sitting around hoping that a trade will go your way or continue in a particular direction is a recipe for disaster. It is this hope that can leave us unable to adapt to the changing conditions of the market and can put our trading in jeopardy.
So, if we are unprepared for what the market does how can we save ourselves from disaster in the markets? How can we prevent these down days from destroying what we are working so hard to build up, namely our bankroll. Wouldn’t it be great if we had a crystal ball to be able to tell us when to change our path?
Well. let me be the first to tell you there is no crystal ball, at least not that I or anyone else I know has found and instead of wasting our precious searching for the holy grail to trading glory how about, we use what we already have at our disposal to stay current with the winds of change in the market? Does that sound good? There is something we can look at on a very regular basis that can give us an indication of trouble ahead. Now, as I just said this is not a crystal ball but it is a tool than when we learn to use it well it can help us get in tune to the ebb and flow of the markets.
The tool I am referring to is the VIX. The volatility index, or as more popularily known, the fear gauge. Simply put the VIX tends to rise when people are afraid of the market falling and climbs when everyone believes or hopes that everything is rosy.
So the question is how does the VIX help us get in tune with the markets? Well, first we need to discuss a truth about volatility and that is periods of low volatility are always followed by periods of high volatility and it is this expansion and contraction of volatility that can give us a clue as to what Mr. Market might be planning. Check out the chart below and you will see the expansion and contraction I am referring to.
Check out the blue circles I have drawn on this chart, these are periods of low volatiilty followed by high volatility afterwards. This does not give one exact timing of when the market will change but it can give a heads up to say hey the volatility is a little low here maybe I should be a little more vigilant. Also if one watches as the bollinger bands start to expand then you can expect higher volatilty in the near future, This is just one way the VIX can help with the market changes. One other way the VIX is useful is using it to see what the market might do next by extracting buy and sell signals from the use of the bollinger bands on the VIX chart. When the VIX gets outside the upper bollinger band then closes back inside the bollinger band then this gives a buy signal and this precludes the bounce we saw today. It does take some time to start to get familiar with the information that the VIX can provide but it is a very good idea to add this chart to your daily routine to see if can’t help you navigate the market waters more effectively.
So, in closing there is no crystal ball but there are clues that the market leaves than can save you money and frustation if you just learn to tune into them.
Coach “Old Money” Holmes