The Winds of Change

“WHEN THE WINDS OF CHANGE BLOW, SOME PEOPLE BUILD WALLS, OTHER PEOPLE BUILD WINDMILLS” – Chinese Proverb

If you’ve been watching the weekly market and trade updates, we’ve been talking about how the market conditions are changing.

For more than a year we have been in an extremely bullish market, so bullish that there was nearly no downside risk. In fact, you could confidently go long on any pullback or you could take on excessive risk to the downside and you were handsomely rewarded for it. And of course you were severely punished for covering your downside risk. It was definitely a year to be in long stock, calls and bullish verticals.

Now of course this is great if you are a bull, but if you were market neutral it took some getting used to.

In order for a true market neutral trader to do really well last year, we essentially had to get used to taking on some downside risk while at the same time, covering our upside risk very quickly. In other words we had to change the way traded by keeping very tight Delta limits on the upside and rolling the dice on the downside so to speak.  For those of us who took that approach it has served us well, but no more.  The conditions are changing.

During late January and early February we got our first significant down move since 2012, which wasn’t even that significant but it was twice the size of anything we’ve seen in over a year.

Since January, the 14 day (ATR) average true range of the Russell 2000 has been creeping higher. It is currently at just under 20, a level we haven’t seen since 2011. In fact we have only seen this level during two short periods in the last five years. Once was after the flash crash in 2010 and the other was during the 2011 crash and the volatility that followed.

A 20 point average true range is essentially telling us that we should expect of 15 to 25 point range on the Russell 2000 on any given day. That’s a lot. And typically with an average true range this high, the market starts to get very choppy. What this means is that if you were doing really well in 2013 you’re likely going to have to make some changes to be successful in the next few months and possibly longer.

To help yourself quickly adapt to the new market conditions, the best thing to do is to look back on the charts when we have seen similar market conditions and back trade them multiple times until you’re confident trading in the new environment.

For more tips on identifying and adapting to market changes click here to learn about our Trading Triangle Program !

Live with passion!

John Locke