There has been tremendous volatility in many futures markets, and it’s a great time to be involved in them. Volatility is what traders dream of. It presents tremendous opportunity, but at the same time – risk.
Last week, U.S. equities suffered their worst three-day fall since November 2002, with the S&P 500 ending the week on Friday, November 9 at 1453. The bleeding continued on Monday, November 12 with the S&P 500 dropping another one percent to 1439. Then the market bounced back. On Tuesday, the S&P 500 rallied 42 points to 1481 after four consecutive days of pounding. As of this writing, Tuesday’s gains have held, but look for more volatility in the weeks ahead.
What is causing all of this volatility? There are so many factors weighing in on this market right now: rate cuts, inflation, crude oil, sub-prime mortgages to name a few. As I mentioned, volatility presents unique opportunities for traders and investors that can handle the risk.
All the factors mentioned above are definitely weighing in on this market. I wouldn’t start preaching gloom and doom, but I do think these factors, especially the sub-prime issues, are going to keep this market in check.
Let’s look very briefly at bird’s eye view of this sub-prime mess. In 2004, 33 percent of all mortgages were adjustable rate mortgages (ARMs). This year, $400 billion of those loans have or will be resetting. Next year, $1 trillion worth of those loans will reset. This alone should keep any major bull markets from developing in the near term. I think problems will get worse before they get better, and the sub-prime issues will continue to be a drag on equities.
The magnitude of the sub-prime issues seems to be unknown. Some are saying this crisis could be worse than the Long-Term Capital Management hedge fund meltdown, in which the fund last $4.6 billion in 1998, and almost took the U.S. economy down with it. Others are comparing it to the Savings and Loan crisis of the 1980s, and a very small number are even going as far as to compare it to another Great Depression in the making.
On the technical side, let’s see what the charts show. Referring to the weekly December S&P 500 futures chart below, the red line is the 8-day moving average, the blue line the 21-day moving average, and the green line is the 50-day. Despite Tuesday’s rally, the S&P futures closed just below the 8-day moving average, indicating some resistance there. Since November 7, we’ve seen lower lows and lower highs than each prior session, a bearish sign technically speaking. We also had seen some crossovers that indicated this market would be correcting back. You can see the 8-day moving average had crossed the 21-day moving average, and the 21-day had crossed over the 50-day. Crossovers are good indicators of changes ahead, and this time, it was for the downside. I see the current trend remaining lower.
Traders are asking me now, are we at a bottom? I think picking tops and bottoms is a very dangerous way to trade. I don’t know how low the market will go, but I do think it is safer to be on the short side of equities right now.
There are some good opportunities given these intraday swings for day-traders who want to avoid the risk of holding a position overnight. We are seeing bigger daily ranges. If you are thinking longer term, and you missed the sell-off, I wouldn’t jump in yet, whether you are bullish or bearish.
However, I do think selling strangles is a good strategy. Selling strangles involves selling a call and put at a lower strike price and hoping the market stays within a range before expiration of the options. Selling strangles requires you to be flexible and ready to change by hedging your futures outright position or adjusting it with options.
For those looking at the long term, I think there will be some good buying opportunities. For those interested in trading with a short term time frame, there are many opportunities in these markets given the daily swings we have been seeing. Regardless of your time frame, disciplined risk management is absolutely necessary in these volatile markets.
Michael Sabo is a Senior Market Strategist with Lind Plus, Lind-Waldock's broker assisted division. He can be reached at 312-788-2940 or 800-798-7671 or via email at msabo@lind-waldock.com.
Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.
You can hear market commentary from Lind-Waldock market strategists through our weekly Lind Plus Markets on the Move webinars, as well as online seminars on other topics of interest to traders.
These interactive, live webinars are free to attend. Go to www.lind-waldock.com/events to sign up. Lind-Waldock also offers other educational resources to help your learn more about futures trading, including free simulated trading. Visit www.lind-waldock.com.
Futures trading involves substantial risk of loss and may not be suitable for all investors. © 2007 MF Global Ltd. All Rights Reserved. Lind-Waldock, Futures Brokers, Commodity Brokers and Online Futures Trading. 141 West Jackson Boulevard, Suite 1400-A, Chicago, IL 60604.
