The Fed has a crucial decision (or is that non-decision?) to make: whether (or not) and when to raise the Fed Funds target rate. In anticipation of the Fed’s next move, markets have been skittish, as I expected. Rising volatility in stockmarkets has been marked. Last week, the Dow plunged by 500 points (3%) on Thursday and Friday, but recovered that ground on Monday and Tuesday.
Such churning is typical when a date-certain event is widely anticipated. The good news is that these conditions are ideal for traders looking to make large short-term profits. But for traders who focus on the bigger picture, such action is disconcerting, to say the least.
Today, the Fed announced the result of its latest monthly deliberations: for now, the rate is staying at 0.13%. But markets will surely remain highly volatile – and this volatility could last a month at least until the more important December meeting is held. That meeting is the really important one; Yellen has already signalled the likelihood of a rate rise then, although it will be ‘data-dependent’.
US economic data is weak – a rate rise could be disastrous
The data Yellen is talking about certainly hasn’t suggested a runaway economy. For instance, latest US retail sales came in woefully short of even the modest expectations (and there wasn’t even snow to blame). The Producer Price Index, likewise, plunged even further into negative territory, demonstrating the waxing power of deflationary forces.
And yesterday, US industrial production weakened even further to produce two consecutive negative months. The trend remains hard down off the November 2014 high. The strong dollar must surely have had an impact on exports.
If I were running the Fed, such data would certainly not encourage me to start raising rates – on the contrary, I might give some thought to lowering them, and even dust off the quantitative easing (QE) software program.
So we are back to the old ‘bad news is good’ rule for stocks –will my alternative outlook that stocks are set to make new all-time highs play out?
Protecting your capital in a volatile market
When forecasting market action, we are all in the land of probabilities. As the famous physicist Niels Bohr said, “Prediction is very difficult, especially if it is about the future”.
Today I want to show you how I handle market volatility – and extract major profits no matter what the twists and turns are by using my split-bet strategy. I will use the Dow as my case study and use a small bet size to illustrate.
I took a short trade on 5 November at 17,860 at £2 per pip. My aim was, if the trade worked out, to take half off if a suitable target was hit, and then leave the other half open and move my protective stop to break even. This is in strict accordance with my break-even rule.
The market took some time to break below my blue support line, which it did one week later. At no time was my protective stop in any danger. So I was content to sit and wait (sometimes, patience is required!).
Wave 3 was an easy one – it was long and strong, which is a requirement for a third wave. Momentum had fallen into what I call the oversold zone. This was all I needed to believe a temporary low had been reached – and I knew it was time to invoke my split-bet strategy by covering one half of my £2 short bet at the 17,200 level.
That produced a banked profit of 660 points, or $660 profit on a £1 bet. The other half I kept running and moved my protective stop on it to the entry price of 17,860.
Of course, we now know that the market has been in sharp rally mode this week and my remaining short £1 bet has been losing value. But I am not concerned – I have a good banked profit and the worst case scenario is that I am stopped out of my open trade at break even. My comfort level is high.
Now compare that with the mental state of a trader who did not use the split-net strategy. He or she would be getting more and more anxious as the market rallied to see his or her paper profits vanishing. And that anxiety could induce a rash decision such as covering all of the trade right at a rally top (so as to keep at least some profit).
And to see the market collapse soon afterwards without him or her on board would surely drive anyone to drink!
Being in a calm mental state is absolutely essential for good trading – and my split-bet strategy is one way to keep on top of your emotions. Highly emotional trading is bad trading.
I realise many traders find it difficult to take profits when they have a terrific winning position. After all, their egos have been boosted – and there has to be much more profit in it, surely. But most traders who have years of success under their belt know when and how to take some profits off the table. Markets can turn surprisingly rapidly and a great winning trade can quickly turn bad.
And that is a confidence-destroyer like no other.
I now have the luxury of deciding whether to put back my short £1 bet I took off at 17,200 with the market back up to what could be my wave 4 high at the 17,500 – 17,600 area.