The majority of people active at financial markets focus on the stock market. Stocks offer a good opportunity to trade or invest for both, those with very small budget as well as those with significant resources.
In case you have read few of my previous articles on this blog, you might already know that I mainly sell options and so use the opportunities in the stock as well as in the futures markets.
Speaking about stocks, we can see in the last weeks that there is some turbulence. The major indexes consisting of U.S. stocks, such as S&P 500 or Nasdaq, are currently without a clear direction. More and more articles appear in the news, writing that we stand before a market correction or that a correction has already begun which will result in falling stock prices. Although, I do not pay much attention to the news and market analysts, it might be clever not to go all-in in the stock market right now and that has its reasons.
I cannot foresee the future, as some market gurus can (or at least they believe so), but even for us mortals, there are some signs which help us to better understand what is going on.
“Look under the hood” of the stock market
First thing to know: The biggest players in the stock market are institutional investors. These are investment funds, pension funds, hedge funds, funds of funds (basically everything what is called “fund”). These players have so much money that they can influence the price and that is their advantage. However, there is also a disadvantage for them, which we might use. When they want to close their positions, firstly, it doesn’t go unnoticed and secondly, it might take quite some time. You can recognize when the institutional investors are selling if you look properly. In the last three Thursdays (10, 17 and 24 August 2017) for example, they were selling. Look at the charts and you will see as prices fell down while the volume of traded stocks increased. (Some useful information on this topic can be found in the book written by William J. O’Neil, founder of Investor’s Business Daily.)
Next signs one can follow
The next sign, which raises our attention, is that the stock indexes stopped reaching new highs. To understand why it is important: A major correction in the stock markets does not happen out of the blue. When markets regularly reach new highs that is always the safer period for a trader. However, once the institutional investors determine that a certain price is already enough to take huge chunks of profits, they begin to sell. This happens very quietly as nobody wants the prices to go down too quickly, i.e. before institutional investors sell all their shares and that might take a few weeks. They cannot damp millions of shares at the markets because the prices would plummet. They sell an amount of shares, than buy some shares back to stabilize the market. This activity of the institutional investors means that the chart does not reach new highs, but moves sideways for a while.
Few days of selling does not mean that a market correction will happen! It just means that the probability is higher now, when the institutions sell more often. Ultimately, the market can go also up as other players might begin to buy or some news might pop up.
Other signs that there are some turbulences in the market is that more and more put options are being traded. This means that more people want to “buy insurance” against falling prices in the stock market. There is also increase of volatility in the markets in comparison with what it was in July this year. We can go with these signs on and on.
What is the best to do in the situation like we have today?
I have begun to focus more on selling futures options. In particular, futures options on grains (corn, soybeans…) or softs (sugar, coffee…). For example, options on gold futures might not be ideal for this purpose. They would not bring much difference as gold is heavily influenced by the developments in the stock market. I have reduced the positions of sold options in the stock markets while sticking to my rules. Selling stock options is always a possibility, but overall, I do not want to be involved in the stock market with more than one third of my portfolio.
I know some people who only sell options (mainly put options – betting on increasing prices) in the stock markets. This or being long in the stock markets apply for many people. Some may wonder that we do not always want to put all eggs in one basket. That is why, I will start a small series in this blog, as of next week, comparing futures options with stock options. I will try to provide more information about how to sell futures options and focus on the differences. This might be useful especially in times like this and you might explore more the possibilities in the field of futures options.
To conclude, I want to stress one thing. The above-mentioned does not mean that the stock markets will collapse. It just means that a correction is at the moment definitely possible and there are some signs indicating a bit of unrest. Therefore, we might be more watchful and not bet all the money on raising prices in the stock market.