Volatile Markets Can Make You Crazy

Volatile Markets Can Make You Crazy

Posted on September 16, 2011

What does the current volatile market have in common with a dog chasing its own tail? Both are irrational and both can eventually make you crazy unless you change your perception.

It is hard to feel good, during volatile markets, even if you have proper diversification. High market volatility is caused by emotional / irrational investors. If your portfolio is volatile, it means your current diversification is not working.

In fact, investors with stable, well diversified portfolios can still be affected by the emotions of the markets. Volatile markets are marked by both large up and down days. Most people feel like they have too much risk during the big down days. On the other hand, it can feel like we are missing the boat on the days when markets experience a big rebound.

One of our most important indicators, in determining the market’s emotional state, is the Canterbury Volatility Index (CVI). The CVI acts similar to a thermometer in that it measures changes in volatility. A CVI reading below 90 reflects a stable or rational market. A CVI above 90 is moving toward an emotional or irrational market.

The Canterbury Volatility Index is part of our Portfolio Thermostat Matrix. The matrix identifies 12 different Market States or market environments. 6 Market States are Bullish, 2 States indicate Caution and 4 States are Bearish. Almost all market corrections, of more than -10%, have occurred during the 6 Market States labeled as Caution and Bear.

On 8/4/11 the S&P 500’s CVI (volatility) increased from 78 (rational) to 102 (irrational). The 102 CVI reading caused our Thermostat Matrix to shift to Bear -Market State #6. Three days later, the CVI increased to 150 and soon after peaked peak at 171. A CVI above 150 is "bonkers irrational!"

Here is a chart showing how big the Dow’s fluctuations have been from 8/4 through 9/15 (yesterday).

8/4/11 -563 8/19/11 -173 9/2/11 -253
8/5/11 -635 8/23/11 322 9/6/11 -101
8/9/11 430 8/24/11 144 9/7/11 276
8/10/11 -519 8/25/11 -171 9/8/11-119
8/12/11 126 8/26/11 135 9/9/11 -304
8/15/11 214 8/29/11 254 September 12th, 13th, 14th, and 15th Total up 418
8/18/11 -420 9/1/11 -120  

Now think about this. The stock market can experience a correction of about -10% at anytime for any reason. That is just what markets do. The Dow Jones Industrial Average experienced a normal correction of about -10%, from its previous peak, on 7/21 through 8/4. The really volatile (irrational) period began on 8/4/11.

The Dow closed at 11,384 on 8/4. On 9/14/11 (yesterday) the Dow finished the day at 11,433. Guess what? After all the craziness over the last six weeks (see the chart) the Dow is net up +0.0043% for the period. That means - NO CHANGE from 8/4 through 9/14! After all the worry and hand wringing, after break-in news flashes and hours of air time on the major networks, the Dow is back to where it started on 8/4!

What can we learn from the last six weeks of craziness?

All markets get irrational from time to time. Most of the market’s profits are made during the 6 Bullish Market States. And most of the big losses occur during the 6 Market States that reflect Caution and Bear market environments.

When we are in one of the 6 “risky” Market States, our primary goal should be stability and avoiding losses. There is plenty of money to be made, with much less stress, during the 6 Bullish market States.

Currently we are in Bear-Market State 12.

Every effort was used to provide accurate data and mathematical calculations to provide, what we believe to be, accurate results. Canterbury Investment Management, LLC, and its principal owners, make no guarantee of completeness or accuracy of data or calculations as well as conclusions of any statistical data or information contained in the simulation illustrated on this page. Past results or performance is in no way a guarantee of future results.

Canterbury Investment Management: Tom Hardin

More About Tom Hardin

As Chief Investment Officer, Tom Hardin, Chartered Market Technician (CMT), makes all the final decisions on all investment and portfolio management decisions for Canterbury Investment Management. Tom has more than 30 years experience in the investment management industry and has broad breadth of knowledge. He is known as an innovator, educator and been revolutionary in the advancements in portfolio and risk management.