Well I certainly hope you like rollercoasters, because that is exactly what the markets feel like at the moment!
After the massive tariff shocks of last week, this week we had the 10th largest up move in the history of the S&P500 (close to close in percentage terms). I am not going to get into the drivers of the volatility this week because unless you are living under a rock you can’t miss it, plus who needs more politics in their life?
What I do want to discuss is WHAT DOES THIS MEAN?
When I saw the 9.5% close to close rally it got me wondering what it means for the markets and does this give us any indication about what might happen in the near term.
I took the 50 largest up moves (again % close to close one day moves) since 1928 when my data starts and plotted the size of the move against the percentage move over the FOLLOWING 50 trading days (see below).
I was expecting to see that the markets collapse after a move like this (yes I am a bit of a bear at heart), because many of these large moves happen below the 200 day EMA.
But I was surprised!
You can see in the chart below that the average 50 day % change after the largest 50 up-moves was 4.9% (compared to an average change of 1.5% for all possible 50 day periods from 1928 to present). So there is actually quite an edge to going long after massive up-moves like this.
I did wonder if this was skewed by the occasions when the large up move occurred above the 200 day EMA, but even when I remove those, the average 50 day change was still 4.2%.
So there is some evidence for an optimistic near term, however, it is important to be aware that the numbers above are just averages. The range of 50 day price moves following the largest up moves was:
- Maximum +62.6% (10 June 1932)
- Minimum -33.8% (10 October 1929)
So if you could play the game an infinite number of times you would certainly go long and expect to win over time, but we don’t get to play this game very often, and there is still a decent probability of a -20% move down from here.
I really like doing this sort of investigation because it shows what could happen (not what will happen). Understanding the range of outcomes is useful because it can help us do some mental scenario analysis on our portfolio.
Ask myself questions like:
- What would happen to my portfolio if the market fell 20% over the next 50 days?
- What would happen to my portfolio if the market rallied 62% over the next 50 days?
- Does my mix of systems and capital allocation protect me sufficiently from such a massive range of possible outcomes?
- Am I mentally prepared for anything that could happen?
- Would I have confidence in my systems to keep me safe (and profit) in the full range of possible outcomes
Mental scenario analysis is one of the best ways to improve as a trader because it prepares you for what could happen, so that if it does you can act rationally. It also gives you extreme scenarios which you can use to pressure test your important things like:
- Capital allocation
- Position sizing
- Long/short exposure
- Trend following / mean reversion balance.
This builds your confidence that you will be ok no matter what happens.
Looking at the daily chart of the indices below is really quite interesting. The US markets had a huge bounce on Wednesday but are still well down from their peak and below the 200 EMA. This is useful to remember as despite what the scatter chart above shows, long term holds do perform much worse when the index is below the long term moving average, and volatility on average is much higher.
Remember ever trade I make is 100% systematic, so I am not making any discretionary decisions here, but if I was, I would be waiting to see if the market managed to sustain a rally and rise above the 200 EMA before I got excited about a new up trend.
Probably the most interesting chart to watch from the above is the Hang Seng, because the Hong Kong market is now sitting just on the long term average after a pretty savage 10% gap down (yes I did get whacked by that a bit this week). However, it is still the strongest out of the 5 indices shown above.
Most of my long HK trades have now exited and my short system is yet to turn on, so it is a waiting game to see which direction the portfolio will tilt next.
With 10 year bond yields still rising despite the rebound in the stock market I suspect the next move in the market will be down, but my portfolio is sitting on a lot of cash so it won’t matter much to me which way it goes.
In addition to the bond yields rising, the global stock indices outside the US are mostly showing red for the week. It is possible that the relief rally in the US will be short lived. Again please remember this is not a prediction for you or me to take action on, it is all about mental preparation so that we don’t get caught by surprise.
A real bright spot in the portfolio this week was the Dolphin Mean Reversion Strategy which buys deep dips in a leveraged tech ETF. This strategy has captured a 15.6% gain so far in April and has coped remarkably well with the volatility as you can see from the equity curve below. You can subscribe to this strategy and get easy to follow daily signals emailed to you by clicking here.
Having a mean reversion strategy like this which profits in such highly volatile conditions is a really good diversifier if you are a long side trend follower or if you have a largely buy and hold portfolio.
Your Trading Personality
Understanding your trader personality is crucial for achieving consistent success in the markets. Each of us have strengths and challenges that influence decision-making, risk tolerance and how we approach the markets.
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Trading Tip: Trading in Volatile Environments & Bear Markets
In volatile trading environments and bear markets, the key is to ensure your strategies adapt to the market’s behaviour and avoid trying to predict its next move.
Here’s a tip: diversify your trading systems to include strategies that can profit in different market conditions—trend following for sustained moves, mean reversion for sharp reversals, and short-selling systems for declining markets.
This way, no matter what the market throws at you, you’ve got a system in place that’s designed to thrive .
Additionally, ensure your systems have an “off switch.” For example, a trend-following system might only activate when the market index is trending up, while a mean reversion system might only trade when volatility is within a specific range. This prevents you from trading strategies that are out of sync with current conditions .
Finally, focus on managing risk. Position sizing and stop-loss rules are critical to surviving wild swings. In bear markets, systems with wider stops will often perform better because of the increased volatility, but always ensure your risk per trade remains within your tolerance. This approach keeps you in the game while allowing your systems to perform as intended.
Quote of the Week
To me this means don’t try to predict or be clever, just follow your systems.
I was thinking it might be fun to include a segment in this newsletter where we test the ideas readers come up with and share the results. If you have a trading idea you would like backtested and evaluated, please reply to this email and I will do my best to include one of them in next week’s newsletter.
Enjoy the weekend, I can’t wait to see what next week brings in the markets.
Remember – You are only one trading system away!
Adrian Reid
Founder, Enlightened Stock Trading
