Quite honestly, the down days in the market and the increased volatility values shouldn’t come as a significant surprise to investors and traders who have been active in the markets over the past several years. Though we’ve seen a bit of an uptick early this week, markets tumbled from its all-time highs last week, and gold and silver experienced aggressive selling with gold breaking below a technically important long term support level of 1500.
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 S&P 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 the S&P losing 18% at its lowest point of 1105. Again, bulls stepped in and the index 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 S&P pulled back 7.1%. The rebound over the summer took the S&P 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 S&P has run to its all-time recent highs resulting in a bullish run of 15% early this month.
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 three 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.