I'm Not Looking for Volatility to Let Up - but I'm Not Worrying, Either

With the Dow Jones Industrial Average, NASDAQ Composite, and S&P 500 all in negative territory for the year, it's no wonder some traders are running for the hills.

At the same time, we have some investors in rose-colored glasses ready to call the market bottom each time we hit a new low. And then we hit a new low. And then we hit a new low...

Starting to see a pattern here?

Remember the Trading Commandment I mentioned? "The trend is your friend... until it isn't."

Well, the trend we're dealing with now is an elevated CBOE Volatility Index - Wednesday marked 51 consecutive days above 15 - and a market on the decline.

I have to admit here that my forecast that stocks could find some kind of bottom when the VIX hit 25 is toast.

Now I'm looking for a VIX above 30, at minimum. I'll tell you why - and what to do about it...

But first, buckle up...

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Here's the No. 1 Thing Dragging the Markets Down

With so many traders on the sidelines protecting their money from the continual drops and most others selling as soon as there's a pop, there's just not enough volume to keep the rallies intact and the market afloat.

And no, those starry-eyed investors who keep thinking we've hit a bottom just aren't enough to keep this market going. But they do represent enough trouble to make themselves the market's worst enemy as it slides down the "slope of hope."

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That slope is just one driver behind the market's drop on Tuesday afternoon, before a slight bounce helped indexes finish just a little higher overall.

But we're dealing with a sustained downtrend, and nothing is more representative of that than the four biggest indexes all forming death-cross patterns: the Russell 2000 (11/14), Nasdaq (11/27), S&P 500 (12/7), and yesterday (12/19), the Dow.


You see, a death cross is when an equity's 50-day moving average crosses below the same equity's 200-day moving average. Historically, the death cross is a very bearish - go figure - sign for a stock, ETF, or index.

Each time, I've written to my subscribed readers about the impending pattern and the fallout that would ensue from such a trend.

Each time, the market turned for the worse. That's the trend we're dealing with, no matter how many times someone wants to call a bottom simply because it "has to be."

If this sounds pessimistic, please don't get me wrong: The moneymaking opportunities can be even bigger at a time like this.
It's only bad if you're "long" on armfuls of speculative stocks. Which leads me to another one of my Commandments...

Here's the Best Way to Play It

Strictly speaking, it's a Commandment-plus that states, "Don't fight the tape... and DEFINITELY don't pick up pennies in front of a steamroller."

And the "tape" made itself even more prominent Wednesday afternoon when the U.S. Federal Reserve said it would raise short-term interest rates by another 0.25%.

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I told my Night Trader subscribers that "Given the market conditions, we're going with protective puts on Philip Morris as traders "foil up" for the street fight tomorrow. By the way, bonus points if you can name the "foil up" movie."

That's exactly what happened at 2:01, a Street fight over what the Fed's policy statement meant for stocks. Of course, stocks plummeted immediately, giving up the gains they had made for the day leading up to the rate-increase announcement - a result many analysts, experts, and talking heads have expected all week given the uncertainty around the market and interest rates.

And that's how we get to today.

I noted that the Dow has now finished its own death cross, which was the last of all four indexes. The last time this happened was January 2016, just as the "Trump rally" was finding its legs. Within a month, the market had taken off and was set on a course for new all-time highs.

And guess what? The market was in a similar long-term technical situation then, as the S&P 500 was trading below its 20-month moving average. This is the line between a bull and bear market.

Looking back at those charts, I expect to see the same action grinding sideways while the volatility machine chews up more people's portfolios. You're not going to see me trying to pick up pennies on Wall Street while the steamroller is coming through.

I'm not sitting around idle either, though. Remembering that the trend is my friend, regardless of its direction, I've found bountiful opportunities using protective puts in the Night Trader portfolio. Our recent recommendations have allowed my Night Traders to close seven winning trades in a row in December for an average of 77%.

I'd recommend anyone else do the same - look for the opportunities in put trades on companies under pressure. And if you go long, hedge, hedge, hedge, hedge - like an English country road.

See, the trend - even if it looks scary - really is our friend!

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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.

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