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Financial Literacy

A Goldilocks Market for Short-Term Traders

The VIX is very near Goldilocks territory.

If that statement sounds cryptic, it’s not. In fact, it’s very straightforward. It’s also a very good thing for investors, and short-term traders in particular.

The VIX is the Chicago Board Options Exchange Volatility Index. It measures market volatility by looking at put and call options on the broad market of S&P 500 stocks.

If the VIX is high, the market will see big swings, either up or down. That was the case in mid-March, when the VIX peaked above 80. On March 16, the S&P 500 fell nearly 12%, the third-biggest daily loss since 1926. Four days earlier, on March 12, the market posted its sixth-biggest loss.

Daily moves of 4% or more were common throughout the month. That’s absurd volatility.

Absurd Volatility

Before the pandemic struck – and struck fear into the hearts of investors – volatility was relatively low. The VIX spent much of January in the 12 to 13 range.

Here’s a chart of the VIX in 2020 so far.

Approaching Goldilocks Volatility

Since the volatility spike in March and April, markets have settled a bit and the VIX has dropped to the mid-20s. It’s around 27 as I write this.

A VIX reading much lower than 15 reflects market complacency and can be a warning sign if it remains there too long. And a VIX above 40 tells you it’s an extremely volatile market where most investors are uncomfortable and many choose to stay away until things calm a bit.

But the sweet spot for the VIX is between 15 and 25. A VIX reading in that range means stocks are moving at a healthy clip – but not swinging wildly – and profits can be made from those movements, either up or down.

Goldilocks for Traders

Certain trading and investing strategies lend themselves to certain environments.

Chief Income Strategist Marc Lichtenfeld recently wrote about different trading styles. He mentioned four types in particular:

  • Day trading, in which “action junkies” enter and exit their positions all in one trading session
  • Swing trading, with traders using technical analysis and quantitative tools to hold positions from a few days to two weeks
  • Longer-term trading, with a time horizon of a few months
  • Long-term investing, for those who don’t want to watch the market so closely and typically hold their positions for several years or longer.

(The Oxford Club has long recommended all of these strategies as part of its diversification among asset classes, investment strategies and timelines. That’s part of the Oxford Wealth Pyramid, which you can read about here.)

Slightly elevated volatility – in the range markets are now seeing – is ideal for traders working with shorter time horizons. These would be the day traders and swing traders, as they have the nimbleness to get in and out of positions quickly and profit from up or down market moves.

With so much uncertainty about the future, markets will very likely continue to be volatile.

“Anxiety breeds volatility,” Quantitative Strategist Nicholas Vardy told me when I ran all this by him. “And volatility in turn offers opportunity.”

The market is always changing. Some strategies will work better in bear markets, some in bull markets. Some strategies benefit from low volatility; others love an elevated VIX.

For short-term traders, now is a golden age.

Good investing,

Matt


About

Matt has worked as an editorial consultant to the International Monetary Fund, the World Bank, the Economist Intelligence Unit and other global macro-institutions. He wrote about markets and economics for U.S. News & World ReportBloomberg News and Investor’s Business Daily, among other publications. He also worked for several years as head of political economy for a Financial Times-owned macroeconomic consulting firm, advising hedge funds around the world. Matt’s claim to fame is that he’s interviewed two U.S. presidents and has spoken with five Federal Reserve Chairs from Paul Volcker through Jerome Powell. Matt also served as The Oxford Club’s Editorial Director for two years.

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