Market shocks are unpredictable and dangerous. By definition, they cause huge losses for most investors because they move in the opposite direction to most market positions.

So far, stock markets driven by central bank stimulus have almost recovered from the price shock as a result of the huge panic among market participants caused by the coronavirus pandemic. But markets never move in one direction and there will certainly be a new price shock in time. These market movements are the biggest risk for investors and traders because they can wipe out most of everyone’s capital.

When the market is in a steady upward trend, traders and investors often forget about past price shocks, which bring huge declines in asset prices – in 2000 the Internet bubble ended with a loss of 90% for the Nasdaq index, and the financial crisis of 2008 led to a 50% loss to the Dow Jones.

As before, so in the current market crisis, many investors were unprepared, even though they are professionals. So how can you do better?

Not all price shocks are the same

Although each price shock looks unique, they all have two common characteristics:

• Volatility is extremely high
• Prices move relative to most market positions

Solutions:

We can see that the combination of high volatility and a sharp drop in market prices are the primary signal to move to a cash position or close current long positions.

When positioning in short positions, we must observe the opposite – a rebound in prices with a decrease in market volatility, which is a sign of closing short positions.

The price shock of March 2020 began in a way almost identical to the market sale of December 2018, as shown in the chart below.

The first big drop came after the market hit new highs above 2,900. Prices then rebounded in the short term before declining further as volatility continued to move up. In the December 2018 example, prices fell by 19.5%, but the volatility threshold did not exceed 30%, as the chart below shows, which was a signal for many participants to position themselves again in the market.

In contrast to 2018, in the current market sell-off, the value of volatility exceeded the threshold of 30%, which gave an additional impetus to the market downward movement, forming the price shock that the market suffered.

Each price shock develops differently. We must hope that our rules make sense and that we are protected during the worst of events. As a general rule in such market movements, traders and investors must comply with the following two criteria:

  • With extreme volatility of over 30% and a three-day decline in the market – moving to a cash position and closing current long positions
  • With a drop in volatility below 30% after the extreme values ​​above 30% were registered and a three-day uptrend in the market, re-positioning in long positions. Many trader investors prefer to even wait for the volatility level to fall below 25% to seek new market entry.

 Junior Trader Radi Djuma

Varchev Absolute Trader

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