Friday, October 10, 2008

This is the End, My Only Friend, The End...

You remember that song by The Doors, right?

It certainly feels like it's the end. The question is: The end of what?

A) The end of our Financial System?
B) The end of this wretched sell-off in stocks?
C) Or just the end of another week?

It certainly feels like sometimes it is the end of the World, but luckily, it's definitely C, and quite possibly B as well!

Today we saw probably *the* most volatile day EVER. I'm not using hyperbole, it was the most volatile day probably on record. The VIX index is a tool used by traders to measure fear in the market. Numerically, it just represents volatility, but usually when things are volatile that means that traders are scared and buying options (protection). This index usually oscillates between about 15 & 30...30 being high volatility (lots of fear) 15 being low (lot's of complacency). Well, throw those old metrics out the door because today we saw this index shoot up over 75 - to put that in context, we've never seen that in the 20yr history of this measurement.

Usually such readings (above 35, let alone above 70) signal a capitulation. People throwing in the towel and selling at literally ANY PRICE. I can just picture it now: "I don't care what price you get, just get me out!" people shout at their brokers. This is usually a very positive sign, because it means we've reached the height of fear. And as the old saying goes, when their blood on the streets, buy stocks (or something like that).

And there was certainly some blood on the streets today. Today's what we like to call a whipsaw. Before the stock markets open, traders like to bet on whether it will go up or down on the day - they call this the futures market. Well, the futures market this morning was saying the stock market would be down about 300pts. So right on cue, the market opens up 300pts lower and proceeds to go down 500points by about 9:45. By 10:30 the market was back up to unchanged on the day (up 500 points from the bottom) and by 2pm we were down 500 points again. At 3pm, the market starts going up--ALOT. By 3:30, it's UP 300 points--ON THE DAY. Think about that for a minute, the market was down 500 points, and now it's up 300, meaning it moved 800 points in half an hour!! And you guessed it: We gave it all up and closed the day -125points.

So what to do? Well, I bought a few things on the day, including:

GE - Maker of Lighbulbs, Jet Engines, and Comedies like "The Office" (NBC).

XLF - the S&P Financial Index. This stock is comprised of about 80 Financial companies. Think of it as a mutual fund that trades like a stock. Why on earth buy financials? I think we might get some major announcement over the weekend that will send financials higher. More Bailouts!

MDY - The Midcap 400 - This stock lets you own all the stocks in the Midcap index. Midcaps are medium sized companies. The S&P 500 is the top 500 largest companies, whereas the Midcap400 is the next largest companies (usually $1-$4bn in size). I just like this is a generic play to get exposure to the stock market (like buying an index fund).

Are we out of the woods? I don't know, but I think we're getting closer. Days like this signal everyone is headed for the hills. It doesn't help that Monday is Columbus Day and many traders were out of the office today. But patience should be rewarded - I Hope!

It's always darkest before the dawn!


kate said...

Interesting post. I never really knew what exactly the futures market was. So, question, is the futures market set up kind of like a gambling spread in sports..except people are putting up assets (in the forms of stocks, bonds, etc.)?

How risky would you normally characterize the futures market?

Sean said...

The futures market certainly attracts a gamblers mentality. These guys are based in chicago and use leverage to amplify returns. So for instance if they are trading $50,000 of a position, they'll only need to put down like $3-4k to do it, so they can take huge risks without having to fully invest in it. But with leverage you're also amplifying your risk.

So lets use the previous example - i put down $4k, and buy (or "go long" as they say) a futures contract. Lets say it's on the Dow Jones Avg. I'm betting that the price of the index will go up. Lets say it goes up 1%, I've made $500 on my $50,000 worth that i just bought, except I only put down $4,000, so for every 1% the market goes up, i've made 12% ($500/$4000). But it works the opposite way as well, so if the market goes down 1%, i've just lost 12% of my investment.

Incidentally, that's also what's causing so much pain the housing market - if you only put down 5 or 10% on your home if it goes down, even a little, you've lost almost your entire investment in the home. Leverage giveth, and leverage taketh away!