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Toss a Trading Game Plan When Volatility Jumps? Not So Fast

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January 12, 2016
Volatile times? Stick to your trading plan

Yikes. The S&P 500 (SPX) is down 5.9% in the first week of the year? You heard that right. The Stock Trader's Almanac's "First Five Days" early warning indicator registered its second worst reading on record dating back to 1930.

Is this a precursor of more volatility to come? Possibly. Emotions tend to run high as market volatility picks up, but that’s usually no excuse to deviate from your trading plan.

Investors and traders alike need to keep a cool head amid the frazzled financial headlines. "The toughest time to buy stocks can be when the world is panicking," says JJ Kinahan, chief market strategist at TD Ameritrade.

"If you’re only going to buy when things look great and sell when things look terrible, it implies you’re buying high and selling low. That’s the exact opposite of how we know most investors make money over the long term," Kinahan adds. "If you think it’s a good time to buy, but you’re nervous, consider adjusting your size. If you were going to buy 500 shares, you may want to cut your size and buy 200 shares, for instance. Your overall plan should remain the same."

Kinahan likens the current environment to a boxing match. If you get knocked down by the first punch, you might feel a bit dazed. To win, the boxer has to have a plan and stay focused.

History Repeating?

Sam Stovall, managing director at S&P Capital IQ, points to historical evidence worth reviewing in the wake of the recent trading tumult:

1.   Since World War II, there’s been a positive total annual return for the SPX 80% of the time.  

2.  The SPX was in negative territory at one point during the trading year in 87% of all years since World War II.

3.  One benefit of dollar-cost averaging, in a 401(k) plan for instance, means that when markets decline during the year, investors are buying at lower prices.

Ready for Earnings?

As the barrage of Q4 earnings hits, investors may wonder how the recent economic, currency, and stock market rumblings out of China could affect S&P 500 companies with significant direct and indirect exposures, Stovall notes. Here's what to look for: "The greatest concern will likely be 2016 guidance and whether this year’s trajectory of [earnings per share] revisions will emulate the significant and consistent erosion seen in 2015, in which the 8% projected gain at the start of the year is now likely to end with a 1% shortfall—for the first full-year earnings decline since 2009," says Stovall.

Oh, and about that interesting seasonal indicator we mentioned up top? The First Five Days indicator is an early warning system to the Stock Trader's Almanac's January Barometer indicator and has a decent track record.

"The last 41 up First Five Days were followed by full-year gains 35 times, for an 85.4% accuracy ratio and a 14% average gain in all 41 years," says Jeff Hirsch, editor of the Stock Trader's Almanac. Seasonally oriented investors are likely to be watching full-month performance closely for clues on what could lie ahead.

Remember the boxer who got felled on the first punch: keep your focus and stick to your investment plan.

TD Ameritrade clients can use the Analyze Tab (figure 1) to consider the risk associated with individual stock positions, including total positions over time and over changing price. The feature also works in the platform’s paperMoney® feature, where traders can practice their approaches before live-trading. 

thinkorswim analyst tab

FIGURE 1: DEEP LOOK?

The analyze tool has its own tab that can be accessed by logging into TD Ameritrade’s thinkorswim® platformFor illustrative purposes only. Past performance does not guarantee future results.

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