Morning Market Thoughts

Good morning. The futures are down in a really big way this morning as the short volatility trade continues to unwind. Wondering why the market is doing what it’s doing? The underlying dynamics are pretty complex, but I can explain the generalities quite easily.

The easiest trade in the world has been short volatility. Volatility has been draining out of the market for several years, and it’s been quite profitable to just short one of the VIX Exchange Traded Products (ETPs) or Exchange Traded Notes (ETNs). Many traders started looking at it as free money. Every month the volatility shrunk further. Why was volatility shrinking? Perhaps it’s because of central bank manipulation, or something else. For our purposes, it doesn’t really matter. What does matter is that there is no such thing as free money. Sooner or later, there is a day of reckoning.

This is what happens when the trade becomes so obvious that everyone is in it. The most obvious trade is typically the trade that you don’t want to make. If you bought the ProShares Ultra VIX Short Term Futures ETF (UVXY) on January 24th when it broke above $10, you’re now up 200%, as the UVXY is likely to open slightly above $30.

For today, here’s what you should be thinking about. None of these dynamics impacts individual stocks at all. The market will gyrate wildly this morning. So will the stocks you hold. But how does the unwinding of the short VIX trade impact stocks like Netflix ($NFLX) or Amazon ($AMZN)? Answer: It doesn’t.

If you’re fairly new to trading, today will be pretty instructive. I’d say that there is a greater than 50% chance that we’ll actually close higher on the day. This is what capitulation looks like. If you are an active trader, you’ll probably be able to trade this swing today. Just make sure you stick with LIQUID issues.

As noted for the last week or so, the damage that’s being inflicted on the market is not just financial; it’s psychological. And it’s going to take a while for that to be repaired. It’s highly likely that we’ll see more downside over the next month or so. Beyond that? No one really knows. But I don’t view this pullback as a real buying opportunity for long term holders. Short term traders? Sure. But this is now a very very volatile environment. Such an environment is dreamland for active traders — daytraders and swing traders. But for the longer term investor, this is the kind of environment that can be very confusing.

Remember Fitzpatrick’s First Rule of Trading: Don’t Lose Your Dough.



Don’t forget about tomorrow’s interview with Mark Minervini. Mark is a Market Wizard and has been trading almost 35 years. I had a long chat with him last night and I can tell you that he understands what is going on now very very well. He has had a very large short position on the Dow for about two weeks, and it’s paid off handsomely. We’ll be chatting about the current state of the market, including his outlook for what’s ahead. I’m sure that you’ve already registered for the event. But if you haven’t, here’s the link:

See you tomorrow at 4:30PM/ET.

Market Update

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