THE NEW VOLATILITY

If you are a self-directed investor I’m wondering whether the stock market makes you nervous? It should.

Bear markets, which are natural corrective phases, are getting worse. The last two averaged a 53% decline, which was 35% worse than the average bear market since 1960. While the recoveries have been generous, to say the least, most Self-Directed investors are not mentally or emotionally prepared for the New Volatility. And it’s only likely to get worse. The largest 1-day down draft ever in the Dow Jones Industrials (more than 1000 points) occurred in August 2015. This chart of the Dow Jones Industrials since 1928 illustrates what I’m talking about. 

Today’s markets are more volatile because machines (algorithms) dominate order flow. Each year, the majority of math Ph.D.s are recruited by Wall Street. The machines they program operate algorithmically, that is, with pre-programmed rules. They have no discretion. They buy and sell autonomously and without hesitation. 

The global network of high-speed computers and fiber optic pipes providing instant access to information exacerbates a natural market phenomena called ‘herding.’  Herding occurs when buying and selling is motivated by sheer momentum. Today, the size of the herd has expanded… it’s global, which means the capital flow per unit of time is many times larger than in the pokey 20th century. 

Herding is a follow-the-leader phenomenon. It’s a boon during bull phases, because it sustains the uptrend. But when the music stops, herding works against Mom and Pop investors who are trying to manage their own savings and retirement accounts. Sudden bursts of volatility from 10,000 machines selling all at once inspire fear in most people. In practical terms, therefore, the New Volatility means that Wall Street has become more adept at shaking out the little guy.  

To keep abreast of the changes, the self-directed investor/trader of today needs to be more nimble and more disciplined. Studies show that men in particular tend to overtrade, take excessive risks, buy high and sell low. And the behavior gets worse under pressure. The solution is to adopt a more objective (algorithmic) approach to entries and exists, risk and reward because algorithms virtually eliminate subjectivity and emotion from trading.

 

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