Good Day Tackle Traders!!!

What a wild couple of weeks we have had in the markets!  We have seen volatility jump up and we have seen a rather large range in the major indexes.  This kind of volatility for shorter-term experienced traders is awesome.  However, what about the longer perspective newer traders?  Do they see this volatility as fun?  I have heard from more than a few rookie traders that this volatility is keeping them up at night.  Now, we have discussed in this blog a few times before that if your positions are keeping you up at night then you are either trading too big or trading what you don’t understand.  We are not going down that road this week but we are going to muse about some of the ways that people try to offset market volatility so that they can breathe a little easier when these massive moves come and go.

As members of Tackle trading you have probably heard the coaches talk about insuring your portfolio against downside movement, in fact, my friend Coach TC (Tyler Craig) has put together an entire course dedicated to the subject, by the way, his course is fantastic and I highly recommend you check it out.  One of the more common ways to insure a portfolio is to buy protective puts.  This can be done in a few ways, there can be general longer-term protection or shorter-term more specific protection.  The latter part of this protection is what we will be going through today.

From the shorter-term perspective, one of the ways to determine where to put the protection we want is to look for significant levels of support and then buying the puts underneath that level.  This is a very common practice that usually works out well in most market type environments, however, there are times where volatility picks up, as it has now, and this can make this practice infinitely more challenging.  This is the time where Mr. Market can throw you for a loop if you are not diligent.  I will go over the particular scenario that reared its ugly head this week and we’ll see if we can understand how or if we can prevent this issue from rising again in the future.

Before I paint the picture of this weeks scenario, I need to breathe some context into this idea.  The title of this week’s blog is The Big Market “Dummy”.  I have the word “Dummy” in quotes for a reason, please allow me to explain so that one understands where the title for this blog comes from.  Before becoming a trader I had another passion known as the sport of Rugby.  I played Rugby for the better part of my adult life to this point, on and off for approximately 20 glorious years.  Now, you may be asking why are we talking about Rugby in a trading blog and the answer to that is Rugby and Trading have a few things in common.  Trading and Rugby are both action-packed and sometimes unpredictable but also have methods to their respective madnesses.  In this weeks case the market, specifically the S&P 500 performed a maneuver that in Rugby is called a “Dummy”.  A Dummy is where the ball holder pretends to make a lateral pass getting the defender to react to this move without releasing the ball and then running past the defender to score a TRY.  I won’t go any further down the rabbit hole with Rugby as that is a conversation that is better had over a pint or two.  This fake-out move, called a “Dummy” is quite rarely performed with perfection.  Check out the video below for a good demonstration of the technique.

As I was saying the S&P500 pulled off a very successful “Dummy” this week on Monday.  The support level at 2630 on the S&P500 futures appeared to break on Monday only to rally back up and close higher on the day.  Now, one may ask why was this a fake-out or a “Dummy”?  It was the depth of the down move that puts it into a “Dummy” category. A rundown of this magnitude would have most reacting to it.  You can see this with the long lower shadow on the candlestick in the chart below.

You see if you had put on a protective put underneath the aforementioned level and were triggered in only to see the market roar back and render your insurance useless all the while costing you a few shekels then you can probably see how this was a finely executed “Dummy” by the market.  So could this have been prevented?  Maybe?  If we used a measure of volatility in determining the spot to put the protection on then maybe, but more likely this move was too big to stop us from jumping in especially if you had an order waiting to buy protection as the support fell which is a very common practice as well.

The reality is that this happens in trading, we can’t have it perfect all the time.  Sometimes we are going to get “dummied” by the market and that is part of the game of trading but if we stick to good solid back-tested rules for placing orders then in the longer-term these fake-outs will be nothing more than a short-term nuisance.

Happy Trading All,

Coach Holmes