Clouds Ahead – Protect Your Portfolio
Markets have taken a sharp turn toward volatility over the last two weeks as coronavirus fears have escalated.
After spending all of 2019 without a single-daily loss in the S&P 500 worse than 3%, we’ve experienced four such sell-offs since last Monday alone. And more could be on deck — volatility tends to cluster.
Right now emotions are running high among investors.
But remember, there are several ways you’re able to make money during a market crash.
Furthermore, it’s times like these when it’s crucial to follow your instruments — not your gut.
That’s not just true in the trading world — it’s also life or death in the world of aviation…
I’ve been obsessed with flying ever since I was a kid. I logged my first hour of flight time in a Cessna before I even had my driver’s license. Today, I have a commercial pilot’s license — a few years back, I even had a part-time job on the weekends as a flight instructor.
And it turns out the trading lessons we can learn from flying are critical to staying airborne as an investor.
If you’ve ever flown on a commercial flight, there’s a good chance you’ve flown through some clouds — maybe without thinking much of it. But for a newly minted pilot, clouds are extremely dangerous. They take away your visual reference to the horizon, making it incredibly difficult (or impossible) to control your airplane.
This is what it looks like from a small plane:
Not much of a view, right?
There are plenty of psychological and sensory illusions that pilots need to be trained to ignore when flying through clouds.
You might think you’re flying straight and level but you’re really in a descending left turn.
So to fly through clouds, fog and bad weather, the FAA requires you to have an instrument rating — a pretty grueling course of training that ensures you’re qualified to fly solely by reference to your flight instruments.
If you want to go through clouds, you also have to file an instrument flight plan — every commercial flight you’ve flown on was on this type of flight plan.
In 1954, the University of Illinois conducted a study where they put 20 noninstrument-rated pilots in a flight simulator and then simulated instrument conditions. On average, it took 178 seconds for the test subjects to lose control of their pretend airplanes.
That’s a pretty sobering statistic.
You’d think that if you have an instrument rating, you’re good, right? Nothing to worry about?
Well, not exactly.
While reviewing accident cases, the FAA and the NTSB found an interesting trend — even instrument-rated pilots were losing control and crashing airplanes in instrument conditions. But it was only happening when they inadvertently encountered bad weather.
How was it possible that folks who were properly trained and flying capable airplanes were crashing simply by encountering conditions that they routinely flew through without issue?
Simple: It had to do with preparation.
When you know you’re going to be flying through real instrument conditions, you’re in a different frame of mind than a pilot who’s just buzzing around the pattern on a nice day.
In instrument conditions, you’re sharper and more alert — because any sort of system issue in the airplane could become an emergency while you’re “in the soup.”
On a nice day, you can fly more “seat of the pants,” but in bad weather, it’s all about precision and procedure.
Trading works exactly the same way.
As a trader, it’s crucial to always be “on instruments.” After all, clouds can pop up out of nowhere in the market.
And we’re smack-dab in the middle of them right now.
The good news is that our instruments — the data looking at statistically similar periods in the markets — aren’t showing any major red flags. At least not yet.
But What If I’m Not a Trader?
The same applies to a long investor. Don’t go running for the hills selling off your portfolio in times like these.
Tech stocks especially, while volatile, can easily swing back the other way when there’s even a hint of positive news.
Often times too they’re shielded from market action because of outside catalysts, news on new technology or clinical dates.
Take for instance the SPDR S&P BiotechETF (NYSE: XBI) — an ETF that tracks a basket of smaller biotech stocks.
While the rest of the market’s been down on the week, XBI is up over 5%.
Taking this all into account, it’s not yet time to sell off your positions.
Ray and I will continue to monitor the markets and give you the latest up-to-date information for the latest action.
I’ll share some of the new datapoints streaming into our trading lab in the days ahead. Stay tuned.
Jonas Elmerraji, CMT