COPING WITH VOLATILITY
by George Kleinman
Editor, Commodities Trends
June 11, 2007
Last Monday morning, the Dow Jones futures were trading above 13,700. Thursday evening, the market traded as low as 13,205 before closing Friday at 13,435. The blue chips traded in a 500-point range in less than one week.
Last Monday, crude oil opened at $64 a barrel. By Thursday, it had reached $67.40, representing a $3,400 profit or loss on just one futures contract. (The margin deposit required to trade a crude futures contract is $4,000.) By Friday, it had lost nearly all of those gains.
Last Monday, the US Treasury Bond futures were trading around 109. By Friday, as Treasury yields spiked higher, they had bottomed out close to 105, representing a nearly $4,000 per-contract move. The margin deposit required to trade one bond contract is only $1,350. This was almost a 300 percent move based on the margin requirement--in just one week.
Last Friday, silver made a $4,000 per-contract move in a 24-hour period. (The margin requirement to trade one contract is currently $4,000.)
The markets are certainly volatile right now. How can a trader cope?
July Crude Futures
A greater than $2,500 per-contract move in just one day last week:
June Mini-Dow Futures
A greater than $2,500 per-contract move within three days last week:
July Silver Futures
A greater than $4,000 per-contract move in less than two days last week:
First and foremost, keep this in mind during volatile market conditions:
Anything can happen. During the last 48 hours of the Enron debacle, the stock was in free fall, collapsing to a new low of $10 a share. (It traded at $90 not all that long before.)
I had a client in the metals business who�d partnered with Enron in specialty metals trading. He said he was buying Enron stock at $10, telling me it was a screaming buy because its pipeline assets alone were worth more than $20 a share. This made sense to me, so I bought some there, too. But I also immediately placed a stop loss at $8 and was stopped out in short order.
We now know the books were cooked, and that the collapse in what was supposedly the seventh-largest US company wasn�t over until its share price hit zero. So forget logic, and forget what you believe the fundamentals are because, ultimately, the market is always right.
As Lord Keynes once said, �The market can remain irrational longer than you can remain solvent.�
Seven Rules For Successfully Coping With Volatile Markets
The trend is your friend, so don�t fight it. If a market appears to be in free fall, don�t try to bottom pick. If a market appears to be in a trading range, you don�t have to commit to a new position until it declares itself (by breaking out of the range, indicating strength or weakness). If the trend has turned down in a particular stock or commodity, you can consider shorting it, but you shouldn�t be a buyer until there�s solid evidence the trend has turned back up.
Use stop loss orders. Stops are defensive protection devices against financial ruin. Remember, you can only control what you can control. You can�t control the markets, but you can control your equity to a major extent via the judicious use of stop loss orders.
Reduce your trading size. Adjust your risk-to-reward ratio to a workable level.
Buy the strong, and sell the weak. Last week, while many of the financial markets were in collapse, both wheat and cotton actually closed higher. (Therefore, there�s no reason not to be long those particular markets.)
Be Selective. Trade less. Lower your exposure. Trade spreads, use options, go to cash, tighten your stop loss orders, employ hit-and-run strategies. There are numerous techniques that can preclude you from sticking your neck fully out during chaotic times.
Be unemotional. Never fall in love with any position. No matter how good a stock or commodity has been to you in the past, today is a new day.
Take responsibility. You can�t blame the markets, the hedge funds, your broker or the weather. You're responsible for your own result, and only when you acknowledge that fact will you overcome adversity and ultimately triumph.
© 2007 George Kleinman
KCI Communications, Inc.
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McLean, VA 22101
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Futures and futures options can entail a high degree of risk and are not appropriate for all investors. Commodities Trends is strictly the opinion of its writer. Use it as a valuable tool, not the "Holy Grail." Any actions taken by readers are for their own account and risk. Information is obtained from sources believed reliable, but is in no way guaranteed. The author may have positions in the markets mentioned including at times positions contrary to the advice quoted herein. Opinions, market data and recommendations are subject to change at any time. Past Results Are Not Necessarily Indicative of Future Results.
Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.