Last Friday’s stock rally was legit. The large jobs beat kicked-off a buying frenzy that finally sent the small-cap-laden Russell 2000 Index through the pivotal $1600 resistance zone. Equities ended on a high note across the board.

And then, our Tweeter-in-Chief got bored on Sunday night and decided to toy with the Chinese by threatening a tariff increase. The markets, which have arguably been buoyed by optimism over a trade deal eventually being struck, threw a fit with risk assets plunging across the board.

All U.S. Indexes opened down 1.5% to 2% this morning with anything Chinese related bearing the brunt of the nastiness. Since it’s been a while since we’ve seen a bona fide rug-pull, I wanted to talk a bit about how to deal with down-gaps like this.

First: Chill

In the hierarchy of nasty down-gaps, today doesn’t come close to landing on the leaderboard. Had we fallen 3%+ at the open, then we’d have something to talk about, but 1.5% to 2% isn’t all that bad by historical standards. The reason there was so much shock factor this morning, however, is because we’re in a low volatility environment. 2% in this market is actually a pretty big outlier. Let’s get more specific:

For the volatility geeks among us, the SPX ended last week with an implied volatility of 12%. That means a one sigma move was 0.76%. Two sigmas was 1.51%, and three sigmas was 2.28%. This morning’s puke lands between two and three standard deviations.

My first suggestion for a day like this is to chill. Just relax. I suspect almost all of us were leaning bullish into the weekend and thus unhappy to be greeted with such a dastardly down gap. But this goes with the territory. You have to be willing to stomach some level of volatility regardless of your trading style or strategy. This is what volatility looks like. You enter the weekend, pleased as punch with your well-behaving positions. And then, come Monday, your positions are stabbing you with knives.

Second: Risk Check

Never forget, you are the one who decides the size of said knives. If through improper position sizing you choose to equip a stock with a machete-sized sword, then, well, that’s your fault. Day’s like today remind us of the unparalleled importance of risk management.

What allows you to keep a cool head during bloody opens is holding properly proportioned positions. If you awoke to a portfolio down in the high single digits, then perhaps you need to re-assess the level of leverage you’re swinging. Alternatively, if you were only down a percent or two, then I’m sure it was easier to kick back and let the trades play out.

Third: Adapt

If through a rapid-fire risk check this morning you discovered you were leaning a bit too long, then step one is to get smaller. Reduce your portfolio delta through subtraction or addition. That is, exiting old bullish positions or entering new bearish ones. The former is always easier than the latter, by the way.

If your overall exposure was fine and today’s drawdown manageable then I don’t think you needed to do anything. Instead, sitting tight and seeing how the gap was absorbed would have been smart. As it turns out, buyers swarmed a nanosecond after the opening bell. The speed with which dip buyers got to the business of buying dips was impressive and confirmed that spectators viewed President Trump’s weekend shenanigans as just that – shenanigans. They were unworthy of completely derailing the bull train that has been in motion for months.

Perhaps the best evidence of the markets’ resolve is the Russell 2000 Index (RUT). It led the charge on Friday with its breakout and followed up with one heckuva bullish engulfing candle today.

Color me impressed.

Fourth: Capitalize

My final thought for gaming weak opens like this is to don your contrarian hat and shop for bargains. Not that a down 1.5% to 2% open qualifies as a big-league bargain, but there were still opportunities. Many market leaders offered modest discounts to Friday’s close. How about AAPL opening at the 20-day moving average? Or V and MA? Or DIS?

Perhaps the simplest play would have been selling puts in EEM to exploit the implied volatility spike and ugly down gap.

Did you weather the turmoil okay? If not, take note of the mistakes. Build a playbook so that you’ll be better prepared the next time an unexpected rug-pull arrives.

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