Market volatility is back, but it is in models traders trust.
President Donald Trump's on-again-off-again tariff policy sparked a surge in market volatility, briefly tipping both the S&P and Nasdaq into bear market territory earlier in April when tariffs were announced for virtually all U.S. trading partners.
But then, the White House decision on Wednesday to pause the majority of tariff hikes for 90 days fueled a historic surge in the stock market. The CBOE Volatility Index, meanwhile, is spiking this week as investors process these shifting policy decisions and their implications.
While market volatility can make it risky for market participants to take positions, it also provides a great stress test for traders who rely heavily on models. Investors hoping to make buys and sells should use extreme caution during periods of heightened volatility since the market's direction remains uncertain. Defensive trading methods include using small pilot positions and reducing portfolio exposure.
Tinkering With Models And Circuit Breakers
Jack Kosar, vice president of investment strategy at Asbury Research, tells IBD's "Investing with IBD" podcast that his model is built to ride the long-term uptrend of the S&P 500. However, it does have several safeguards designed to protect him and his clients.
"There are obviously times of extremes where the market is going to correct itself, and we want to put these circuit breakers on so we're not getting spooked out on just a little bit of intraday movement," said Jack Kosar. A circuit breaker in trading is a trigger that temporarily halts activity or otherwise limits a loss.
Getting hands-on with how exactly a model works and tinkering as the market evolves can also prevent a safety mechanism from triggering too often, John Kosar, chief market strategist and portfolio manager at Asbury Research, told IBD's "Investing with IBD" podcast. "We try to let the data-driven nature of these models play out without any interference from us," he said.
"The only reason we use the circuit breakers is there are some times where it's like, if someone decides to drop a bomb, you have something that's going to protect your clients," John Kosar said.
Audio Version Of Podcast
Market Volatility Means Indicators Can Make A Difference
Market volatility means choosing the right indicator can make a huge difference. "If I need a faster horse, I'll look for an indicator that's going to help me provide some alpha," said Jack Kosar. "If I'm looking for an indicator that's trying to help reduce drawdowns, it's a little bit more defensive in nature."
Asbury Research uses the "Asbury 6" internal market metrics, which include the rate of change in the S&P 500, relative performance of stocks vs. high-yield bonds, investor asset flows in the SPY, volatility, trading volume and market breadth.
The idea is to swap out indicators that aren't working for those that could help reduce drawdowns, or in the current market volatility, help investors act more defensively.
Fighting market volatility also means selectively ignoring what an indicator may sometimes tell you, Jack Kosar says. "Is the indicator still behaving normally outside of the extreme," he said. "And if that's the case, that's OK, because I can't build a model that's going to take into account a tweet for a day or a set of policies out of Washington that are different from the status quo."
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