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The Standard and Poor’s 500 Index (SPX) closed Friday at 3271, up 1.6% for the week. That doesn’t tell the whole story. Friday’s low was exactly at Monday’s open. Late afternoon trading pulled the market back up on above average volume. It was the only trading session this week that exceeded the 50-day moving average (dma). In fact, it was the first day to break the 50 dma in 24 trading sessions.

The S&P 500 remains about 4% below its pre-correction high. In my opinion, reality is catching up to the markets as the enormity of the economic damage done by the lockdown is more evident. Current market prices appear hard to justify.

VIX, the volatility index for the S&P 500 options, declined modestly this week, opening the week at 26.6% and closing Friday at 24.5%. We may be accustomed to these levels of volatility, but it is prudent to remain on alert. These are not low levels of volatility. This remains a dangerous market.

The NASDAQ Composite index closed Friday at 10,745, up 3.1% for the week. Several high-tech stocks had earnings announcements this week and almost all traded higher. NASDAQ’s intraday trading pattern on Friday was similar to the other broad market indices, trading much lower early Friday but rebounding late to close virtually unchanged on the day.

The last two weeks in July have been essentially a sideways market price pattern. My personal assessment is that market analysts are beginning to realize the amount of permanent economic damage that has been caused by the economic shutdown. It is hard to reconcile 17 million people on unemployment with a Standard and Poors market index that is only 4% below its pre-correction high. As I wrote last week, I am happy the market has rebounded so strongly, but I don’t understand how that makes sense. Carefully weigh the risks of this market. There is money to be made but manage the risk prudently.

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The Standard and Poor’s 500 Index (SPX) closed today at 3216, down 0.2% for the week. Today’s close broke down through the earlier high set at 3232 on June 8th. The question on everyone’s mind is whether this is merely the breather we expect during a bullish trend higher, or if the market is changing direction. Trading volume for the S&P 500 companies has been running below the 50 dma consistently since June 26th. As I have written before, I believe this indicates that traders are apprehensive about the state of this economy and whether the market has correctly priced in the economic damage. Large amounts of cash remain on the sidelines. Traders are reluctant to “go all in”.

VIX, the volatility index for the S&P 500 options, declined earlier this week to 24%, but popped up slightly to close at 26% today. We often regard VIX as the fear index. On that basis, the general level of anxiety is elevated, but not rising. That tells me that fingers are poised over the sell button on any negative news. Don’t be lulled into complacence.

The NASDAQ Composite index closed today at 10,363, down 1.5% for the week. Today’s decline appeared to find support near the index value from last Tuesday, 7/14. If NASDAQ breaks down through that level next week, there is a congestion of support around the 50 dma at 9933. Trading volume has been running below the 50 dma over this entire NASDAQ bullish run. And that didn’t change this week.

Two very different conclusions from our market analysis are possible at this point. The more positive assessment is the standard observation about bull markets taking the stairs higher and frequently pausing for a breather. A less optimistic conclusion might suggest that market analysts are beginning to realize the amount of permanent economic damage that has been caused by the economic shutdown.

Over sixteen million people are on unemployment. We have not seen these numbers in my lifetime. The final bankruptcy count is still out, but many small businesses will not reopen.  Market price averages that suggest the damage is only on the order of 5% seem naïve.

I am more optimistic by nature, but I have to take the pessimistic view of this market. I am happy the market has rebounded so strongly, but I don’t understand how that makes sense.

Carefully weigh the risks of this market. There is money to be made but manage the risk prudently.

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The coronavirus correction in March took the stock prices of the S&P 500 companies down by 35%. Ouch! How did your portfolio do? As many of you know only too well, the damage isn't over. The S&P 500 remains 8% underwater.

The perennial argument is Buy and Hold vs. Timing the Market. The Buy and Hold camp tells us that it is impossible to sell at the highs and buy back at the lows. Perfect market timing is impossible, but open a price chart of the S&P 500 index. It was obvious to everyone by the last week in February that the market was in serious trouble. Depending on when you started closing positions that week, you would have limited your losses to something on the order of 10-12%.

But the Buy and Hold crowd rode the market down to the 35% low on March 23rd. And those portfolios have still not returned to positive territory. Many investors are afraid to see how badly they have been hurt and are just not opening their accounts. The Buy and Hold crowd became the Hiding Under the Bed crowd.

Some will argue this is a matter of risk. Conservative investors have been told that actively trading their stock portfolio is a high risk game. The results year to date in two of my trading services, each of which mirror my portfolios at Charles Schwab and E*Trade, serve as excellent real life examples.

The Conservative Income trading service mirrors the covered calls and cash secured naked puts in my E*Trade account. When used with solid blue chip stocks, these are widely regarded as the most conservative stock and option trading strategies available to the retail investor. When the market lost 35% in March, this service lost 10%. One month later, this portfolio had returned to break-even for the year. As of today, the year to date returns for investors in this portfolio is +13%, while the S&P 500 is still down 8%. This portfolio takes low risk positions and survived the correction very well. Taking more risk isn't necessary to protect your portfolio from corrections in the market.

Dr. Duke's Trading Group uses a variety of option spreads that incur moderate to high levels of risk. Our low point during the March correction was -36%, approximately the same as the overall market. But that is where the similarity ended. This portfolio had returned to break-even after six weeks. Year to date, our trading group has gained 132%. Members of this group are certainly taking more risk, but they survived the correction very well.

Whether an investor uses conservative, low risk trading strategies or chooses to incur higher levels of risk doesn't affect the trader's ability to survive a correction.

The difference is risk management.

Conservative trading strategies lead to a tighter spread of wins and losses, i.e., the standard deviation of the results is smaller. The average gains over time will be positive if trades are managed well. But these trades take less risk and therefore result in smaller net gains over time.

Trading strategies that incur higher risk lead to a wider spread of wins and losses, i.e., the standard deviation of the results is larger. But, again, the average gains over time will be positive if trades are managed well. One of the fundamental laws of finance tells us that the potential of higher gains is always accompanied by higher levels of risk. The higher returns of the trading group are an excellent illustration of that principle.

The crucial learning here is that the level of risk you take in your trading does not affect the ability of your portfolio to survive a correction. The ability to survive the correction is rooted in risk management:

•    Choose trading strategies consistent with your risk profile.
•    Learn as much as you can about the trades you choose to employ.
•    Trade small. Trading small gives you the time to build experience without losing the farm.
•    Develop and follow a trading system, i.e., a system of rules for entering, managing, and exiting each trade.
•    Both greed and fear are dangerous emotions. Your trading system is the cure.


If you are tired of watching your portfolio swing back and forth in these volatile markets, check out the private coaching and group classes offered by Parkwood Capital. Subscribe to the Conservative Income service or Dr. Duke's Trading Group. If you aren't happy at the end of one month, we will refund your subscription.

Happy Independence Day!

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The Standard and Poor’s 500 Index (SPX) opened this week at 3155 and closed today at 3185 for a rise of nearly 1%. On Thursday, SPX’s 50 day moving average (dma) finally broke above the 200 day dma at 3021. A basic sign of recovery for a stock or an index is when the 50 dma overtakes the 200 dma. The S&P 500 remains nearly 6% underwater from the March correction. Trading volume for the S&P 500 companies has been running very low for the past several weeks. Today’s trading volume at 2.4 billion shares was well below the 50 dma at 3.1 billion shares. Today was the ninth trading session in succession with trading volume running below the 50 dma. I interpret this as general apprehension on the part of traders. We’re nervous about what tomorrow brings, and we are keeping a lot of cash on the sidelines. It is difficult or impossible to analyze what price makes sense for this market, given the extensive damage done by the shutdown. It is difficult to have the confidence “to go all in.”

VIX, the volatility index for the S&P 500 options, closed today at 27.3%. The recent low was 24.5% on June 5th. It may be hard to remember in the midst of this chaos, but volatility was running around 12% back in January. The current levels of volatility serve as a reminder that this remains a dangerous market.

IWM, the ETF based on the Russell 2000 group of companies, traded lower this week, closing Friday at 141.31, down 2.8% on the week. IWM bounced off of its 50 dma at 137.30 yesterday. Weakness in the small to mid-cap stocks has always been a reliable indicator of the market’s acceptance of risk. Like many of our citizens living in fear of the coronavirus, many traders are hiding under the bed, afraid for their investments.

The NASDAQ Composite index closed today at 10,617, a new all-time high for this index. NASDAQ gained 2.5% this week alone. Since June 29th, NASDAQ has been trading nearly straight upward, a run of 8.7%. But trading volume has been running below the 50 dma over this entire bullish run. This reinforces what we see with trading in the S&P 500.

I freely admit that I do not understand this market. Why is it possible that the NASDAQ composite has now set a new all-time high in the midst of the most severe (and self-inflicted) economic damage this country has seen since the Great Depression? Add in the rioting, looting, murder, and arson we are seeing in all of our major cities. Even more surprising, in almost every case, our government has stood by helplessly and allowed the mob to burn our cities, tear down statues, and even usurp public and private property and declare a new state. Many mayors and governors even defend the mob. The rule of law is not being enforced. Our very civilization is being threatened. But you wouldn’t know that from watching the NASDAQ hit new highs. The son of an acquaintance asked his dad why Costco was open, but they couldn’t go to church. Children often see the obvious that adults somehow miss.

You may disagree with my view of current events. A common response once was, “It’s a free country”, but it is now dangerous to express your views. Our civilization and our freedom are under siege. The S&P 500 remains 6% below its pre-correction highs and the Russell 2000 is 16% below its pre-correction highs. This week’s unemployment data improved but eighteen million remain on the unemployment rolls. I certainly wish the best for our leaders as they attempt to resurrect our economy. However, it is going to be a long, hard climb out of this hole.

The risk of this market is most succinctly illustrated by the current levels of volatility. Higher levels of implied volatility also communicate higher risk. As many of you know, the most conservative stock and options trade is a covered call on a blue-chip stock. My Conservative Income trading service has been using those trades this month and we are now up 3.7% for the month and up 13% for the year. You wouldn’t know we had a severe market correction. Those are better than average returns for this type of trading. Those elevated returns are a direct result of the higher levels of volatility that drive higher option prices and higher returns for this conservative style of trading.

The bottom line: It isn’t necessary to continue to hide under the bed from a financial viewpoint. We only took a 10% loss in March when the market lost 35%. And now we are up 13% year to date while the market remains down 6%. That is called risk management. Carefully weigh the risks of this market. Set tight stop losses and follow them with great discipline.

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The Standard and Poor’s 500 Index (SPX) opened this week at 3094 and declined through the week to close Friday at 3009, down 2.7%. Friday’s trading broke the 200-day moving average (dma) at 3021. Roughly speaking, this brings SPX back to where we were about a week ago. Friday’s close is 11% below the high prior to the correction. Personally, I think that represents an extremely optimistic assessment of the economic damage. Trading volume for the S&P 500 companies has generally run below the 50-day moving average (dma) over the past two weeks. I am unsure why trading volume spiked so much yesterday. The spike last Friday was due to quadruple witching, but yesterday’s spike is puzzling.

VIX, the volatility index for the S&P 500 options, which had declined since the peak of the correction, spiked up to 43% on June 11th and closed Friday at 35%. We may be becoming numb to these levels of volatility, but it is worth reminding ourselves that these are historically high levels of volatility. This remains a nervous, and therefore dangerous, market.

IWM, the ETF based on the Russell 2000 group of companies, traded lower this week, closing Friday at 140.24, down 2.6% on the week. IWM broke down through its 200 dma on June 10th and is now approaching its 50 dma at 134.01.

The NASDAQ Composite index tumbled Friday afternoon, losing 260 points to close at 9757, down 1.9% for the week. Perhaps more significantly, NASDAQ surrendered its pre-correction high at 9817 on Friday. This week appeared to be the splash of cold water on the strong bullish trend since the correction lows in late March. It remains difficult to explain why the NASDAQ composite should be valued higher than it was in February after all of the economic damage done by the coronavirus lockdown of the economy. I don’t have hard supporting data, but I think the market pricing that corresponds to the current state of this economy is lower yet.

The S&P 500 is now 11% below its high on February 19th. This week’s unemployment data reported twenty million continuing unemployment claims. How can we have twenty million unemployed and yet value the S&P 500 companies only 11% below the pre-correction high? The media have continued their push to fuel the panic. Have you noticed the shift in emphasis? Since the beginning of the pandemic, the evening news always led with the number of covid deaths and projections of an eventual death toll of two to three million and mortality rates of 10% or more. Now the headlines focus on the number of covid cases, which are increasing as testing becomes more widely available. The mortality rate is now on the order of 0.2% or less, more in line with a serious flu season. And the inconsistencies abound. Our governor thinks it is perfectly acceptable to walk shoulder to shoulder with protesters without a mask but continues to order churches closed.

Regardless of how you view the current events, the high levels of volatility drive higher option prices and offer trading opportunities. On the other hand, higher levels of implied volatility also communicate higher risk. Allow me to illustrate with one example from this week. On Thursday I sold the COUP Jun(6/26) 270 call for $715 and then rolled out to Jul(7/2) on Friday for a credit of $618. I collected $1,333 in two days on an investment of $25,718. Of course, next week could bring a very different story – that illustrates the pros and cons of this trading environment.

Carefully weigh the risks of this market. Set tight stop losses and follow them with great discipline.