Thursday, October 16, 2014

Conflicting Signals

In our post about Flexibility, we posted that successful investors are able to sift through a constant flow of data and synthesize it in a way that aids their trading style.  Oftentimes however, the data flow can become so heavy and overwhelming that it becomes self-defeating for even the best traders.  For instance, when the market enters super volatile, choppy periods or undergoes a trend change, the data flow can easily lead to indecision and second-guessing.

You don't need us to tell you that the market has set up shop in one of those volatile phases for the time being.  It is whipping around with zero regard.  Wednesday marked the 7th day in a row in which the S&P 500 moved more than 1%.  That hasn't happened since 2009.  The S&P was down nearly 60pts during mid-day and we saw the Nasdaq fall as much as 100pts and climb all the way back to flat during the last hour of trading.  Yet somehow, the Russell 2000 was up 1% for the day.  Clearly, this is no market for being stubborn or stiff. 

The conflicting signals being thrown at us demand flexibility.  Here are a couple that have us appreciating the importance of risk management and the flexibility to move to the sidelines...

The last time the VIX has had a similar move was the sell off from March-June 2012 in which the S&P 500 lost almost 11% from peak to trough.  The current moves in the VIX and S&P are near these levels now.  Will the market hold these lows or are we entering a more volatile period ala 2011 in which the VIX exploded into the 40's and we had a 20% market drawdown?

Chart created using TC2000

On a positive note money continues to favor small caps as they have outperformed to upside the last few days versus large caps.  Over the last week, the Russell 2k is actually positive while the S&P, Nasdaq, and Dow have all had loses greater than 3.5%.  We find this as a potential positive as small caps have lead to the downside and are now are attempting to lead to the upside.  A welcomed divergence.  Another positive breadth measure is the % of stocks above their 10, 20, and 50 day averages in the IWM has been moving steadily higher as the index was hitting new lows.  

Chart created using TradeStation. ©TradeStation Technologies, 2001-2014. All rights reserved.

With the information flow so mixed right now, one should be content to be patient and allow the market to tip its hand on the direction of the next sustained trend.

Ryan Worch is the Managing Director of Worch Capital LLC. Worch Capital LLC is the general partner of a long/short equity strategy that operates with a directional bias and while emphasizing capital preservation at all times.

Ryan on: Ryan Worch on LinkedIn, Ryan Worch on Twitter | Ryan Worch Bio