8 Strategies For High Volatility Markets

Common Trading Strategies during normal Volatility

When markets are relatively quiet, like in 2017, active traders are normally searching for stocks with either high intra-day volatility or a news catalyst that will put the stock “in-play”.   Good traders attempt to exploit this movement and profit from it.

Traders in a low-volatility market such as this,  would have a tough time trying to trade a market ETF like SPY or QQQ.  There just isn’t enough movement for traders to consistently extract meaningful profits.  In a low-vol market these instruments are great for position and swing traders that can sit in a trade for weeks while the markets grind out profits.

The High-Volatility Market Environment poses Problems

When the market volatility regime flips from low-vol to high-vol, many successful active traders find their catalyst-driven strategy does very poorly. Their response is usually one of two things.  1. Keep fighting a losing battle or 2. Step aside and not participate.   From my experience, here are the main problems:

1.  Lack of experience in the high-vol environment.   High volatility doesn’t really happen all that often, so new traders have limited exposure to the environment. That leads to mistakes. It’s like my first winter driving in snow after being a life-long Floridian. It was ugly! Even experienced traders need a while to “get in sync” with the market.
    
2. Use the Wrong Strategies:   Traders are creatures of habit just like everyone else. When we find a strategy that works, we instinctively keep going to that well.  Unfortunately the event/ catalyst driven formula that works well in the low-vol market fail in a high-vol market. Why?  Because the market volatility “swamps” whatever event volatility may be present.  For example:  Your favorite stock just had a nice earnings beat and guidance raise, but the market is down 600 points. Who do you think wins that battle?
    
3. Wrong Position Sizes.   When traders, who routinely trade 10 or 20 option contract lots in a low volatility market, try to use the same lot sizes when volatility spikes often get run over and lose a lot of money. When the market is tossing $1.50 5 min bars at you when you’re used to  25 cent bars, things get crazy.

In a high-vol environment, traders need to “flip the script” in order to be successful. Try these strategies during high volatility.

8 Strategies for high-volatility markets

Times of high-volatility should be times you relish, lick your chops, and get well-paid.  Here are a few strategies that have worked for me and other traders I’ve either worked with or observed through the years.

1. Migrate from individual stocks to ETF’s:  Hunting for catalysts in individual names is counter-productive;  the volatility you seek is operating within the whole market.  Focus your efforts on the highly liquid ETFs that all the passive funds hold;   SPY / QQQ / IWM / Sector ETFs.   When asset managers bail on tech, QQQ and XLK are going down. When the yield curve inverts, good bye XLF.  You get the idea. When the algos and funds hit a sector, they take down all the names. These ETFs offer great liquidity and tight option spreads. Perfect instruments for trading. Triple levered ETFs are great trading vehicles if you’re not an options trader.
    
2. Understand the ETF weightings:  Knowing if your instrument is cap weighted or equal weighted is critical. For instance, XRT is an equal weight ETF.  Amazon has the same weighting as Macy’s.  But if you trade XLY, Amazon has nearly a 25% weighting; big difference. If you’ve chosen a cap-weighted index, watch the top 3 to 5 components to get a read on trends and potential reversal points.
    
3. Sell something.  Option premiums get more expensive as the VIX rises.  That means you can get more for an option you sell.  I NEVER sell a naked option, but I will sell against a long position to create a spread, or buy a spread to begin with to lower the overall cost of the structure.  An added benefit beyond the premium you collect is that spreads insulate your PnL against volatility to a certain degree.   A strategy I like to use is the following.   I short by buying PUTs at resistance. Assuming price begins to move down, as it gets close to support, I will look to create a spread by selling puts at a lower strike; just beyond support.  If price hesitates or bounces, the puts you sold will lose value quickly and protect your gains. You can do the same thing on the call side.
    
4. Watch for Confirmation:  In my experience, its unusual for one index to “run away” from the rest of the indexes.  For instance.  QQQ and SPY are both approaching Resistance.  QQQ makes a “baby breakout” but SPY remains pinned under resistance.  You’ll often see QQQ either hesitate and wait for SPY or have a failed breakout if SPY remains below resistance.  Once SPY breaks out, then the both “release ” higher.   Seeing this confirmation visually is a great way to increase the probability of a solid entry.  Same is true of a breakdown.  Today, Friday December 7th, SPY, QQQ, and IWM all closed right on their recent low.   That’s not a coincidence.  When / if the October lows break, the QQQ for instance won’t go by itself. Wait for confirmation by the other indexes, otherwise you might find your ankle in a bear trap.
    
5. Take your Time:  If you are driving in snow and ice for the first time, don’t be a moron by going 80mph. You’ll end up in a ditch.  If you are new to the high volatility environment, take your time. Focus on just one or two ETFs; maybe SPY and QQQ.  Paper trade it, watch it, get a feel for the landscape.  Don’t worry what other people are doing, focus on yourself.  When you feel ready, get behind the wheel and go SLOW.
    
6. Shrink your trade -time expectations.   During high-vol periods, price moves fast. Price can move $2 or more in SPY in just a few 5min bars.  In low -vol periods you might wait all day for a $2 move in a stock.  Be ready to quickly put on and take off trades to either protect gains or cut losses.
    
7. Trade level-to -level using Technicals.   In high-vol markets, when you hear people say the sell off in a particular stock is “over-done” don’t believe it. High-volatility markets are technically- driven markets; fundamentals don’t matter.  It’s about unwinding risk and exposure.  The algos know every trend line, every support and resistance level. They see the declining 50ema and know the February low. Focus your pre-market preparation on identifying all the support levels, trend lines, fib levels etc. Create your trade plan on a level -to-level basis using an “If this, then that” approach. I am shorting at this resistance level. If I get stopped out and price breaks above this level, I am flipping long.   If price hits this level, I am taking profits, etc.   Keep the game plan front and center; then follow it!
    
8. Reduce position size.   When price has shown it can go down 800 Dow points and then reverse up 700 points all in 6 hours you don’t need a jacked-up position size to make great money.  During these swings, a simple 38% fib bounce can terrify you if your position size is too big. Ask me how I know. Keep your position size at a level where you’re not sweating over the color of the next bar.

Putting it all together

Snow and a little bit of ice shouldn’t mean you are sequestered indoors, hiding under your bed in a fetal position.  Enter the high-volatility environment slowly, with caution, and with your eyes wide open. With preparation and practice there’s no need to be scared. Take it slow. Trade 10 shares of a 3x ETF or 1 contract on SPY, QQQ, or IWM. You might get bitten a few times but you won’t die.  Practice trading from level to level, leaning on the technicals to identify probable reversal points.  It will go fine. After you build self-confidence you can broaden your horizons and trade size.

If all goes according to Hoyle, after a few high-vol cycles, you’ll be an armed and dangerous killa!

Chris Buss is a professional full-time trader and host of  www.tradersprofitcompass.com .  I have been involved with markets for over 15 years and use technical analysis to seek out and discover objective long and short swing-trading opportunities. I use options to leverage these opportunities while defining risk. The Trader’s Profit Compass website is devoted to enhancing trader performance. There you will find loads of actionable information and strategies you can apply to your own trading program. My aim is to assist you in becoming the consistently-profitable trader you aim to be!