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“Dump and chase” is a time-tested ice hockey strategy. Typically, one player brings the puck forward, then sends it into a corner of the rink, hoping that one of his forwards will get possession first. It doesn’t work all the time, but its persistence means that it is adequately successful. For stock traders and investors, who seem to have adopted this strategy on a daily basis, it can be woeful.
The past week has been full of instances when traders dumped stocks, then chased them higher, or vice versa. I took the liberty of pointing out substantial intraday moves in the S&P 500 over just the past week:
SPX, 1-Week, 5-Minute Candles (arrows arbitrarily added to show relatively large intraday moves)
Source: Interactive Brokers
This morning’s dump occurred in the pre-market, when poor earnings from Marvell Technology (MRVL) became the latest semiconductor stock to disappoint investors. None of what they said was particularly terrible – 4Q EPS and revenues, and Q1 revenue guidance squeaked past estimates, while Q1 earnings guidance matched expectations – but merely “OK” is not enough for high-flying tech stocks these days. Instead, MRVL fell 17% and dragged a wide range of tech stocks down with it. Hence the dump.
Then the chase. This morning’s selloff took SPX nearly to its 200-day moving average, not quite through it, but then Commerce Secretary Lutnick said on CNBC:
This month, my expectation is the president will come to the agreement today and hopefully we will announce this today that USMCA compliant goods will not have a tariff for the next month until April 2nd. That includes the autos and the autos were the lead in getting this and getting this deal done.
(And literally, as I was pasting that sentence, there was a Bloomberg headline stating, “Trump pauses tariffs on Mexico for USMCA goods until April 2.” No mention of Canada, though.)
As we get whipsawed by the news flow coming from the federal government, it is very important to keep in mind a few things:
- Speedy moves can make wonderful trading opportunities, but they can drive investors crazy. Before you react to news flow, be very clear whether you are approaching your decisions as an investor or trader.
- An opportunistic trader needs to approach highly volatile markets with discipline and with the recognition that the zany intraday moves reflect the reduced liquidity that can occur when volatility reigns. That means that one should set profit and loss parameters before entering a trade and stick to them no matter what. And don’t be driven by FOMO if the market starts to rally!
- Investors should recognize that while unsettled markets bring opportunities to add or subtract to positions, they should avoid slipping into a reactive stance. Separate the news from the noise. Real news that affects a company’s bottom or top line might cause an investor to change views about their holdings, but intraday or daily back-and-forth swings probably do not meaningfully affect fundamental valuations. It is a fools errand for long-term investors to chase short-term fluctuations.
- There is no magic to the 200-day moving average – or any other indicator for that matter. People typically gravitate to round numbers, so the 200-day moving average is more closely watched than say, the 187-day version. The 200-day is meaningful simply because enough people use it as a yardstick. A moving average is quite helpful for determining whether a trend is in place or is being breached. To be fair, since some of the popular round-number moving averages are typically used as entry-exit-stop loss points for active accounts, there might be some informational value to traders. But a minor breach of a key moving average does not in itself imply dire things to come. (That said, other moving averages, like the 30- and 50-day have turned lower, implying that a longer-term trend change could be in place, implying that the preferred strategy for traders would be to focus on selling high and buying low, rather than the ever-popular inverse.)
- Volatility begets volatility. As noted above, liquidity tends to be reduced during volatile markets. In Tuesday’s piece, we highlighted the tactics our as options market making team utilized when markets became unsettled:
- Raise vols
- Widen spreads
- Shrink sizes
These were the standard defensive moves that we undertook when markets got hectic. The logic:
- When there is high demand for anything, one should expect prices to rise. The same applies for volatility protection. The marketplace was eager to buy volatility, so this reflects normal supply and demand.
- This reflects both uncertainty and supply/demand. Wider spreads mean that buyers will need to pay a greater premium to buy, and this also protects the market maker against if the mood changes
- The amount of capital that one is willing to risk should change with market conditions. The riskier the market environment, the smaller the desired commitment.
It should be clear that the latter two diminish market liquidity.
My advice under those circumstances is to think like a market maker. Lower your risk tolerance, raise your price targets, and get paid to provide liquidity by using limit orders inside the wider markets instead of chasing stocks and options.
I can state from decades of experience that market makers particularly enjoy an opportunity to make a little bit extra on each trade. That can cause volatility to persist for some time.
Bottom line – some of you might be enjoying the market’s wild ride, others might be freaked out by it. There are strategies for each in a market like this, but the key is to recognize which type of investor or trader you are and use the appropriate tactics for your style and risk tolerance.
Related: Tariffs Land Like a Lead Balloon—And Investors Feel the Impact