VOLATILITY

There have been some wild swings over the last few days. I was watching the market earlier today and thought to myself, "The Dow is only down 200 points". Only 200 points? Normally that would be a huge down day, but in this environment it's been average. Expect more volatility over the next few days...and maybe weeks.

We got the snap back rally on Tuesday. That was a great opportunity to enter into some new put trades...or to to the Straddle trade (buy an ATM call and put). The market is likely heading lower, but it's impossible to predict exactly when it will make the next move down. There could be other snap back rallies (perhaps one to correct today's move down), so you might have additional opportunities to set up new trades. For others, this can be a very scary time in the market. If you are new to trading, I would recommend that you sit on the sidelines for a little while. These markets are moving very fast and swinging wildly. There can be a lot of money to be made on these swings, but there is also a lot that can be lost.

If you do enter new trades, use limit orders. DO NOT USE MARKET ORDERS!!! I also wouldn't use stop orders. When the market starts to swing back and forth like this, it often triggers all your stops. You might find yourself getting stopped out of every trade...even though many of your expected trade directions end up working out. I didn't say that you won't still stop yourself out of a trade...just that you shouldn't set up the open stop orders. If you are unable to check in on your trades during the day, you could use a contingent stop order. This will only trigger if the stock hits a certain price. The best trade is to just risk the amount that you are spending on the option and not use a stop. Normally this isn't the recommended way to trade the option because you often need a big move on the stock in order to get a 2:1 reward to risk on the option trade. Well guess what?...we are getting big moves. You must be willing to lose the amount you spend on the option. If you put $5,000 in a put trade and you don't use a stop, you better be willing to lose the $5,000 if the trade doesn't work out.

Remember that we trade probabilities. I don't know what the markets will ultimately do in the future. Based on my experience with a number of these volatile market conditions, I would suggest that the higher probability is for another big move down. If we do get another snap back rally, you would want to consider buying some puts out about 60 to 90 days...not the shorter term options. I know that the options are expensive right now...almost double what they were a month ago, but you still need to give yourself some time for the market to make its move. There is a chance that the market will try to retrace this recent decline...possible 38.2% or maybe even 50%. A move back up to that 1227 support/resistance area would represent a 50% retracement. I don't think it will retrace that far, but you never know. THIS IS FOR COURSE 2 STUDENTS: If you know how to use Debit Spreads, you can significantly reduce the cost of these expensive option trades. You can also offset the inflated option risk. I'm trying to move my Debit Spreads a bit more out of the money in order to have the opportunity for 150% to 200% possible returns. You can also try to set up some Credit Spreads when the market makes a rally. Try setting those up further out-of-the-money if you can. It might lower the percentage gain a bit, but It will create a high probability return. Try using the weekly options if you can. There won't be any new weekly options tomorrow because next Friday is August expiration.

One of the reasons why I think we are moving lower is because there are so many people out there saying that the bottom is in and that this is a great buying opportunity. Major bottoms are usually formed when the bulls are beaten up and nobody wants to buy because they feel the market will continue to go lower. This was the sentiment at the March 2009 bottom. I don't think we are close to that level of pessimism...not yet anyway. I think that the banks will continue to suffer. Puts on the XLF or calls on the FAZ (this is a leveraged inverse ETF on the financial sector) would be the best trade there.