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How To Navigate Today's Volatile Market?

Author:

Jack is a volunteer at the CCNY Archives. Before retiring, he worked at IBM for over 28 years. As of 2/2020, Jack has over 100,000 views.

how-to-navigate-todays-volatile-market

Introduction

I read the article in Time magazine page 14 written by Kevin Kelleher. (see link below) After reading it, I did not learn anything new. I thought to myself, I could write a better article than this professional writer. I know more about this topic due to my personal experience with investing. I also have the credibility of delivering real results.

Over the past 3 months of this quarantine due to the COVID-19 virus, I have generated better results than the overall market by 50%. That is to say, the S&P has experienced a drop of 15% from its high after having dropped as much as 25% during the worst part of this crisis. Meanwhile, my personal accounts has only dropped by 7.5% from the high.

- May 2020

How Did I Achieve This Stellar Results?

The questions are how did I do it and what is the lesson for the rest of the investors?

The last few months has been dominated by uncertainty and fear and high volatility. My investing advice prior to this crisis was to invest in SPY for the long haul. This is the most diversified and least costly of investing strategies.

However, what we experienced this past few months is extraordinary. What adjustment needs to be made in order to minimize the downside risks while still invested in the market long term?

The answer is a simple trading strategy that take full advantage of the volatility. In technical terms, it is known as "hedging." What you want to do is limit some of the upward gains in order to protect your assets during a major correction or recession.

The strategy is very simple. You need to trade in pairs. That is to buy and sell equal amount of index funds that produce opposite effects.

I like to recommend this pair of index funds - SPY and SPXU.

When the SPY goes up 1%, the corresponding SPXU drops by 3%.

When the SPY drops by 1%, the corresponding SPXU goes up by 3%.

At a normal trading environment, I would allocate my funds in a ratio of 3 to 1.

ie. ($100000 in SPY $33000 in SPXU)

On any given day, if the market as measured by the S&P index moves less than 1% either direction, I would do nothing.

However, if the S&P is up by 1% or more, I would sell SPY and buy SPXU.

If the S&P goes down by 1% or more, I would sell SPXU and buy SPY.

I would trade a portion of my holdings on any given day. This will allow me to handle the cases when the market is down on several consecutive days.

Equal dollar amount does not mean equal number of shares. The price of SPY now is $295.48 per share, while the value of SPXU is around $14.27 per share. (5/22/2020)

A $10,000 will get you 33 shares of SPY, or 700 shares of SPXU.

If the market went down on three consecutive days, in my previous example, I would sell the equivalent of 700 shares of SPXU and buy 33 shares of SPY on each of the 3 days.

SPY Index Last 3 Months

how-to-navigate-todays-volatile-market

Real Results Based on Actual Data

Over the past three months or so, about 60 days of trading, the S&P has traded or moved over 25 of those days in the condition I described. That means, I was able to apply my hedging strategy almost half of the time.

Every time I did so, I was able to make money, regardless of the market direction.

On average, I was able to make a profit of 2% of my sales.

If the original amount was $100,000, after 25 trades, I would have made $5,000.

(10,000x2%x25= 5,000) in the minimum. That is assuming the minimum case of 1% delta of the S&P index. If the delta is 2%, I would make a profit of $10,000.

SPY Compared to SPXU for Last 6 Months

how-to-navigate-todays-volatile-market

Summary

The title of the article is "how to navigate today's volatile market?"

I just gave you the perfect answer. This simple strategy takes the emotion out of buying or selling a stock. It takes advantage of the volatility and use it to make money either way. That is the proper use of hedging.

A Sample Excel Spreadsheet to Illustrate My Hedging Strategy

Here is link to the Excel file.

Postscript

If you have doubt about my simple strategy, you might think how is it your results any better when you actually show a drop of 7.5%...?

Here is the simple logic. My returns are based relative to the market index. If the market dropped 15%, and my portfolio only dropped by 7.5%, then I am doing much better than the market. Look at this from another view point, assume a year from now, the market return to its high of 29,000 on the DOW. If I did nothing from now till that time, my portfolio would be approx. 7% above my previous high.

Plot of DOW Index Over Past Year July 2019-July 2020

how-to-navigate-todays-volatile-market

The Key Data To Look For...

The Dow was at an all time high of 29,200 Feb. 2020. It dropped to a low of 16,500 at the depth of the Pandemic two months later April 2020. Now in July 2020, it has bounced back to around 26,700.

During the same time period, I have beaten the market consistently. I have not lost as much during the downfall meanwhile I have recovered faster than the market.

Some Related Info

This content is accurate and true to the best of the author’s knowledge and is not meant to substitute for formal and individualized advice from a qualified professional.

© 2020 Jack Lee

Comments

Jack Lee (author) from Yorktown NY on May 23, 2020:

T, luck has little to do with investing for the long haul. If you want to do well, all you need is discipline to save and invest in the index. As you say, over the long haul, the only investment that makes sense is the stock market with the current zero per cent interest rate.

The Logician from now on on May 23, 2020:

The trick isn’t to predict the bottom but to be there when it happens.

What are you refering to as my strategy? I was simply bragging, in reality, how lucky I was. Luck based on years of experience (I was a successful stock broker for 16 years) and educated guesses and the confidence to act upon them.

My strategy from here is and was stated, to buy the dips and enjoy the next bull market. If you have a problem with that you either don’t believe 0 interest rates makes the stock market the only place to invest your money like it did for the last 10 years or maybe you think the greatest advances in technology are behind us. I don’t and this video will enlighten you that technology is on it’s way to astronomical growth.

https://youtu.be/3Hyi2n60NsY

Jack Lee (author) from Yorktown NY on May 23, 2020:

T, the problem with your strategy is no one can predict the "bottom". My strategy is very simple. Invest in SPY and keep some cash on hand, to weather the stormy periods.

In the long haul, no one can beat the S&P which produced average return of 7% per year for the past 30 years on average.

My hedging strategy is just to create a little extra return which capitalizes on the temporary volatility.

The Logician from now on on May 23, 2020:

I was in cash when COVID19 hit the stock market and am in cash now waiting to get back in. Since March, 3 profitable trades on the way down taking advantage of the volatility and 100% in on the day it hit the bottom! Out at the recent top all on three index funds. My performance 40% profit since March.

We’re due for a pullback possibly of up to 10% and then off to new highs no matter what the news as long as it is not a new catastrophe. So from here buy the dips and buckle your seat belt! Stock markets are always up substantially before there are signs we are coming out of a recession.

The key to a renewed bull market - 0 interest rates by the fed for the foreseeable future just like that was the main reason for the recently ended longest bull market in history.