This time last week, equity markets in the U.S. were sitting at or near all-time highs. The S&P 500 made a high of 1597 while the DJIA sat at 14887.
These markets were up over 9% for 2013. The VIX, a measure of “fear” in the marketplace, was sitting at a relatively low level at 12.23. At the time of
this writing, a mere one week later, the situation is starting to look quite different. It really began on Friday when gold and silver experienced
aggressive selling with gold breaking below a technically important long term support level of 1500. The equity markets actually held in well on Friday
despite this breakdown in metals and significant downward pressure in most commodities including copper and oil. A different story emerged on Monday as the
metals breakdown continued in earnest and the equity markets could no longer hold their ground. As of the time of this writing mid-day Wednesday, the
markets appear to be in pullback mode. The S&P 500 is sitting at 1545 – about 3% lower than this time last week. The DJIA is off 2.1% from its high and
the VIX has spiked significantly sitting now at 17.70 indicating that fear and increased volatility are back in these markets.
Quite honestly, these moves shouldn’t come as a significant surprise to investors and traders who have been active in the markets over the past several
years. The ‘sell in May and go away” adage has proven to be a successful mantra for traders in each year since 2010. The pullback in the SPX from
April-July 2010 resulted in a 16% downdraft providing a good entry point from the bullish side that lasted into the first quarter of 2011 with gains of an
astounding 24%! The next pullback came shortly after this run in July-October 2011. This pullback culminated with the SPX losing 18% at its lowest point of
1105. Again, bulls stepped in and the SPX bottomed and ran from this level to 1415 by March 2012. This bullish run did have another smaller pullback within
it but still showed this index gaining 21.9%. 2012 showed a somewhat different pattern in that there were two separate pullback opportunities within the
market. The first came in the month of May as the SPX pulled back 7.1%. The rebound over the summer took the SPX to highs for the year just over 1470 when
another pullback ensued of around 8%. Once buyers came back in at this point in mid-November, the bulls gained control as the SPX has run to its all-time
recent highs resulting in a bullish run of 15% through last week.
We know that, while history does not always repeat itself, we can look to historical price patterns to help establish future expectations for equity price
movement. Since the great recession of 2008-early 2009, all pullbacks in the markets have been met with buying activity and price appreciation. The real
question is just how significant a pullback in the markets may become at this point. If history serves, we may have further downside to run as our earnings
season continues. So far, earnings results appear mixed with many of the “heavy hitters” on tap to report during the next 14 days or so. If the results
continue to come in mixed, it may be “fuel to the fire” for the pullback.
So how do I handle these pullbacks within the markets? Most recently, I chose not to entertain many short duration (less than 3 months) bullish spread
trades as I anticipated a pullback at some near point. I raised a great deal of cash to take advantage of what will be “opportune moments” that I see
coming. As the VIX is rising, option premiums are also rising which will give some great potential trade returns on credit spreads in the upcoming months.
I have begun layering – in very small increments – into short duration bearish spread trades to take advantage of what I believe may be a 5-7% pullback in
the markets for the next several weeks to months. I don’t attempt to time market tops and bottoms but rather find tradable trend opportunities in either
direction in the markets. That’s how you win at this game. I am most grateful to OptionsAnimal for teaching me how to do just that!