How to Handle This Listless, Go-Nowhere Market Environment

by James Brumley | July 12, 2012 10:59 am

Looking for a hot stock? Don’t bother. Ready to tap into a budding sector-based rally? Forget about that too. The unfortunate fact of the matter is, most stocks are starting to look and move like every other stock out there. Ergo, one’s as good as another right now since they’re all rising and falling together, largely to the same degree.

That’s the word on the street, anyway. Goldman Sachs (NYSE:GS[1]) published an analysis on Tuesday telling investors that idiosyncratic risk — the disparity between the market’s best and worst performers — is at very low levels right now. In fact, it hasn’t been this low since (ta-da!) July of last year. It’s a stark turnaround from the great “stock picker” environment we were enjoying at the beginning of the year, where some stocks soared and other badly lagged.

Admittedly, it’s the kind of information many traders acknowledge, then continue to do the same things they always do anyway. Big mistake. History shows this stuff matters.

Proof of the Pudding

A premise can be interesting, but unless traders can attach a number to such a theory, it might fall on deaf ears. Thing is, there are numbers to support the advent of excessively low idiosyncratic risk. And not surprisingly, it was Goldman Sachs that did the number crunching.

Only these numbers weren’t the confirming numbers from this week’s analysis. These were numbers released in March when Goldman first started to bang the idiosyncratic risk drum — which, by the way, hit the nail right on the head.

The bottom line? During the 35 years prior to 2011, idiosyncratic risk — the degree of difference between the market’s best and worst stocks (loosely) — accounted for 60% of the average stock’s return. In 2011, less than 50% of an individual stock’s performance could be attributed to idiosyncratic risk.

The difference between 60% and 50% seems minimal. And from a simple mathematical perspective, it is minimal. But, that 10% difference is where traders find their “edge.” Take that away, and suddenly those traders are throwing the same darts newbies are throwing.

It’s not like Goldman is the only outfit that has come up with the same analysis-based warning, though. Some of the market’s oldest adages express the same sentiment. Here’s an oldie but a goodie: Three out of four stocks move the same direction of the market. A more obscure but perhaps vitally important tip: Nine times out of 10, nine out of 10 stocks aren’t doing anything trade-worthy.

Although neither axiom quantifies the current challenge as well as the Goldman Sachs numbers do, they all point to one idea: There’s little to no margin for error in trading. And now, with lower idiosyncratic risk crimping even the best of stock picks, that margin of error is zilch, if not negative.

What to Do

So if the deck is stacked against traders as well as investors right now, what’s the solution? Though it’s likely some active traders have abandoned their trading endeavors altogether, it’s not like not playing is the only way to not lose.

Here are some ideas for dealing with a dead market:

  1. GS:
  2. explains why:

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