Volatility: It's the longest four-letter word on Wall Street or in investor's minds. It's evil, it's devoid of value, and it's our enemy!
Or is it?
By now, you know I believe volatility is a trader's best friend. That's right, in my Ten Commandments of Trading, No. 8 states, "Volatility is a trader's best friend."
And if you're still in doubt, what I'm about to show you should prove once and for all that there are no profits without it.
Take October, for instance.
October is the gateway to what is normally a generous period for the market. The catch? The markets can be very, very choppy.
Let's take a look...
[mmpazkzone name="in-story" network="9794" site="307044" id="137008" type="4"]
How to Get Volatility "Just Right"
Looking back to 1990, the S&P 500 is 15% more volatile during October than any other month of the year.
The chart below displays monthly volatility for the S&P 500; notice the jump in August and peak in September?
Feels familiar, doesn't it? It should, as the S&P 500 on Friday was registering actual volatility readings that are 213% higher than the beginning of September.
While volatility is actually through the roof, the market's perception of how volatile the rest of October will be is low. On Friday, the CBOE Volatility Index (VIX) is 65% higher than its average readings in September.
JOHN BOEHNER EXCLUSIVE: He was marijuana's biggest foe - now he's its greatest ally. Click here to reserve your spot in a free, online cannabis summit featuring the Speaker...
Hold on! Actual volatility is 213% higher, and the market's perception of the upcoming volatility is only 65% higher?!
This screams something to me, as it should to you, which is that the market's declines aren't finished yet, meaning you should be stepping forward with caution.
Despite the surge in selling and volatility last week, investors are still relatively complacent. This is often a sign that the market has more to work out before stocks are at an investable bottom.
Watch Out for the "Dead Cat Bounce"
Always wanting to quantify these things, I quickly tested the market's reaction to a spike in the VIX, and the results uncovered a familiar term: the "dead cat bounce" (all due respect to those cat lovers out there).
According to my tests, the S&P 500 has a put in an initial rally of around 1% after the VIX make a 40% or higher spike. That 1% rally happens within the first five days, but is then followed by a sell-off between days five and 10.
Finally, after the market retests its lows (and the VIX spikes for a second time), stocks switch back into rally mode for a more robust rally that often carries us back to highs.
So, where does that leave you and I in sorting out whether it's time to load up on stocks or not?
Well, according to the chart and data I used above, the wise move is to wait until the VIX has its chance to make another move higher.
On Monday, the major indexes were able to stabilize after Friday's rally, but the S&P 500 is now doing a tightwire act on its 200-day moving average that, if broken, would serve as the catalyst for that dead cat bounce to play out.
You Have to See It to Believe It: The Night Trader's most powerful tool tells him exactly which stocks are set to go up tomorrow, the next day, the day after that, and beyond. And it is rarely ever wrong. Click here to learn more...
Looking out beyond the next ten days, remember that October's volatility creates opportunity for those traders willing to watch closely enough. I've revised the monthly volatility chart used above to include the average S&P 500 performance for each month.
The distinct cross between volatility declining and returns increasing tells you everything you need to know. Volatility is going to decline between now and the end of the year while returns begin to climb again.
The fools running around trying to avoid the volatility often wind up ignoring this clear opportunity and missing out on some great profits as November opens the door to some of the strongest seasonal trading of the year.
And stay tuned for my follow-up piece where I give you two "Best in Breed" stocks to buy (and profit) despite the risk of a "dead cat bounce."
This Trader Is Betting It All He Can Show You How to Turn $5,000 into AT LEAST $174,500
Chris Johnson is on pace to see 3,390% total winning gains this year.
And now, he's guaranteeing his recommendations will give you the chance to do the same.
If not, he's working for free.
So mark your calendar for one year from today...
Set a reminder on your phone...
About the Author
Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.