Life after Volmageddon 2.0 — When is it Safe to Buy Stocks Again?

I’m sure many of you are wondering what to make of last week. To be fair, even seasoned vets are scratching their heads, trying to figure out what comes next. That’s hardly surprising; in a week of superlatives, the least likely outcome was for the markets to finish unchanged — which they did.

As of Friday’s close, the S&P had rallied 4.3% from Monday’s low, closing the week at $5,344.15 for a modest weekly gain of 0.43%. Encouragingly, the price reclaimed the 100-day moving average at $5,312.60 on a closing basis and looks likely to fill the gap at $5,400, aligned with the 50% Fibonacci retracement.

Although we ended the week higher, the moves were erratic, with the S&P whipsawing violently between rallies and sell-offs. Notably, sellers appear active between $5,300 -$5,350, which ties in with my view that any moves higher will encourage further deleveraging (as will moves lower).

The Vix falling 40 points from Monday’s intraday high of 65 provided the energy for the S&P to rally (vol higher = stocks lower, and vice versa), but the negative dealer gamma added the accelerant.

Monday’s low circa $5,100 was approaching max negative gamma, As such, dealers would have been Bookoo short of e-mini S&P futures. Volatility dropping and S&P rising kickstarted the positive feedback loop, whereby dealers would be forced to cover hedges into market strength.

So far, so bullish. However, Wednesday’s price action was a reminder that negative gamma goes both ways. An hour into the session, the S&P was up 92 pts (+1.77%), before collapsing 133 pts (-2.55%) in a straight line.

I’d expect this nasty, unpredictable behaviour to remain as long as the market is below the gamma flip of $5,482. The danger with negative gamma is that it will get you bullish at the top and bearish at the lows — a recipe for losing money.

So how do you trade it?

In theory, you buy when sell-offs begin to reverse and ride the momentum higher until it stops. Or, you do the opposite and short rallies as they begin to roll over and ride the momentum lower.

In reality, you turn the screens off and recharge the batteries for what comes next. Which is exactly what I did. On Thursday, I departed the madness of Bangkok and headed back to the farm for a few days.

While the view from my home office is great, the wifi out here is slower than an America Online dial-up modem from the early 90s. With that, I am Bangkok-bound in a few hours, so expect a return to video content tomorrow.

And I have to say, after the last few weeks, it was the rest I needed, which is handy because I think this week the curtains go up for Act 2.

Here’s how I think Act 2 plays out….