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Aug 25, 2017

Trading Tips for Market Corrections

By:Sage Anderson

The stock market in the United States has been rallying for so long that some traders in today's market have likely never seen a systematic crash.

And while nobody knows exactly when the next protracted sell-off may occur, the rhetoric coming out of North Korea and Washington recently pushed the VIX to some of the highest levels seen at any point in 2017.

It should be noted that the highest levels of the VIX so far in 2017 do fall short of the historical average in VIX, which is approximately 19.

The recent spike in volatility makes it worthwhile to review some important trading tips that may become useful in the event that a more meaningful selloff materializes.

My own trading career began only a couple years prior to the 2008-2009 Financial Crisis. And at the start of 2007, I was placed on a team that focused exclusively on trading volatility in the financial sector, and I remained there through 2009.

In this role, I had a front-row seat to the buildup and eventual climax of chaos in that sector, and the market as a whole. For those looking for further insight on trading during a market correction, I can confirm from past experience that a recent episode of Options Jive is a great place to start.

The chart below helps illustrate just how strong the stock market in the US has been since those harrowing days in 2008-2009:

As you can see from the above, the market has exhibited a clear one-way trend since SPY bottomed in 2009. And while there may not be a clear end in sight, the stock market will go through a period of protracted sideways or down movement at some point in the future - that is guaranteed.

Preparing for that eventuality, and how you’ll address adjustments to your current strategic approach, may allow you to quickly unlock new opportunities as they are presented.

Getting back to market corrections, one theme that almost always presents itself when the market goes south relates to correlations - specifically, that diverse assets become more highly correlated. In laymen’s terms, that means investors selling into weakness become less concerned about the supposed "quality" of a given asset - everything and anything gets sold.

Likewise, strategies (position structures) also become more correlated. In a sell-off what often matters most is units. How many short contracts are in the portfolio, versus long contracts? Similarly, the difference between "defined risk" and "undefined risk” positions also becomes clearly illustrated.

It’s for these reasons that tastytrade often stresses the importance of keeping position sizes small and consistent. This not only diversifies risk across the portfolio but also allows traders to rebalance their portfolios quickly, when necessary.

During market corrections, the type of underlying security in the portfolio can also make a big difference. Single stocks can go bankrupt, whereas indices and ETFs do not. During times of heightened volatility, traders can limit risk by trading exclusively in indices or ETFs to minimize unsystematic (i.e. stock specific) risks in their portfolio.

Another important skill to master during market corrections is “keeping your cool.” A fast moving market may get the adrenaline pumping, but that doesn't mean it's the right time to take ill-advised (or outsized) risks.

Maintaining discipline, trading within your risk profile, and keeping your head - just like in a sideways or upward moving market - is always the path toward bringing home consistent, positive returns.

We hope you'll take the time to review the complete episode of Options Jive focusing on market corrections when your schedule allows.

If you have any questions or comments related to this material we hope you'll leave a message below or reach out at at your convenience.

We look forward to hearing from you!

Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

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