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Trading in a Low Volatility Enviroment
At the time of this writing the S&P 500 index has closed higher for 9 consecutive trading days, and with these higher prints, this alpha index continues to carve out new All-time highs. This is quite impressive, and unusual, as it indicates very little supply (sell orders) in the market. Interestingly, this comes after the panic selling triggered after the Brexit vote late June 2016. Since there aren’t many new sellers in the market, and all the shorts are being squeezed out, buyers have to bid prices higher until a willing seller comes along to take the other side of that trade. That’s the mechanism that enables the stock market to continue its ascent. And one must be ready, as this dynamic can change quickly.
If you’re not familiar with the term “short squeeze” this simply means that short sellers are forced to cover as the market moves higher. In the case of Brexit, there were an inordinate amount of shorts in the market because of the uncertainty surrounding the vote. These shorts needed to cover to take profits or cut their losses as the rally extended, thus proving more bids (buyers) under the market.
Another consequence of the persistent rally in stocks (and by extension Equity index futures) is the collapse in volatility. In other words, the daily range in the S&P futures is shrinking. As an example, in days subsequent to the Brexit vote the daily range in the E-mini S&P was close to 40 points (as we can see in chart below).
Fast forward to this week and the range has contracted to 12 points (seen in the lower chart).
That is quite a difference in price movement. The more important question to ask is, how does the rate of change in price effect how a trader makes decisions?
First, the core strategy of finding supply and demand levels to enter low risk, high probability trades does not change. However some adjustments can be made. One that can be made in this low volatility environment is to reduce profit zone expectations. Since the moves are smaller, the profit zones will also shrink. The good news for traders that find this type of environment challenging is that markets are never constant. Volatility will pick up again. Until then, staying patient is truly a virtue. In addition, there are other non-correlated markets to look at. Futures traders should be flexible, and have the skill to branch out into different markets.
The grains (Soybeans, Wheat and Corn) are great markets with plenty of movement, especially around the summer and fall as they are closer to harvest season. The metals market (Gold and Copper) are also excellent markets that have ample volatility. And lastly, the energy complex (Crude Oil and Natural Gas) can also produce many opportunities for the skilled trader.
Should every trader engage in these markets? Of course not. These are alternative markets for those that know what’re doing. Because the opportunities are limited in the equity stock futures one must look to greener pastures.
The bottom line here is that traders need to be skilled enough to participate in the full spectrum of the Futures markets. If you find you’re self limited to only certain markets because you lack confidence or don’t have a good process, then I would encourage you to expand your horizon, but do it slowly. Learn other markets. Their characteristics, tick values, trading times, and what other markets will affect them. In addition, have a low risk, high probability method to participate in these markets. There’s always a market moving somewhere, you just have to find it, and more importantly have the skill and knowledge to participate. Food for thought…
Until next time, I hope everyone has a great summer.
