JeffWhite

Jeff White is a full-time trader in Texas. Blending a technical approach with a thorough understanding of market psychology, money management, and strict discipline, Jeff has enjoyed success in a variety of market conditions since the late 1990s.

Jeff’s Latest Posts

Worried that the market may abruptly reverse after all these recent gains? Wondering about an appropriate hedge just in case it does?

It is likely that we will see a turnaround — even if it is only temporary, and what better time to remind ourselves of that potential than now when in the midst of what feels like a market which may never go down again. That can be a dangerous feeling. The fact is though, it has been an impressive run and may not be done just yet.

This market has covered considerable ground in a short period of time. We’re currently in the 11th week of an uptrend channel for the NASDAQ Composite Index COMP, -0.44% after tacking on 18% since mid-December.

The S&P 500 Index SPX, -0.61% is no slouch, having added almost 14% during the same time. The latter has not posted a 1% decline since late-December, which is a testament to the one-way nature of this market of late. We’re also contending almost daily with the Bin Laden high from May 2, 2011 at 1370.

And whether you’re a bull or a bear, it is easy to agree that we are overdue for a pullback at this point. The market indeed moves in both directions, although some may have forgotten that with all this persistent strength.

After all, every single dip has been bought, keeping bouts of profit-taking quite mild. Bears have been quick to cover shorts on virtually any weakness, while underinvested bulls afraid of being left behind have put cash to work consistently each time they’ve seen red. The result has been a rally powered by both camps as they play the role of buyers.

Think Twice Before Shorting

But what if things do get shaken up? What if we get the long-awaited change of character with channel breaks or failures at key levels like 1370 on the S&P 500?

If we do, shorting may not be your best bet. The fact is, uptrends are still intact going back to last October. Shorting within established uptrends is akin to swimming upstream it isn’t easy and the current is in your face rather than at your back. Additionally it isn’t as if a short-term shift of direction would constitute a new downtrend.

The next pullback may be met with buying before it reaches the prior low from December. That scenario would simply create another higher low. Keep in mind, the bulls have been paid and conditioned to buy the dips, so they aren’t likely to abort that approach until it proves futile at least once.

Rather than shorting what has been a very strong market, a better approach may be to simply get long volatility. That would benefit from what may be an abrupt initial pullback, as well as any change in character which introduces greater uncertainty. Rather than needing prices to decline considerably in order to profit the way you would by shorting this market, volatility could expand as market participants simply become uneasy and begin to alter their recent behaviors.

A direct investment in VIX isn’t possible, so let’s look at two ways to take the volatility trade via ETN’s which are tied to CBOE Volatility Index VIX, +3.76% futures contracts.

VelocityShares Daily 2x VIX Short Term ETN TVIX, +2.99% is one such instrument, which is a levered exchange-traded note. As volatility expands, this product seeks to reflect twice the movement of the VIX futures. This ETN created a low on February 7th at $13.87. Just three days later, it traded up to $21.10 during what was a pullback in the S&P of just 10 points. Clearly the potential is there for sizablele move, and the daily chart now has potential for a higher low with support being found last week at $15.62.

Barclays iPath S&P 500 VIX Short-Term Futures ETN VXX, +2.26% is another ETN which seeks to mimic the movement of both the midterm and short-term VIX futures. This ETN also established a low on February 7th at $23.68, and three days later traded up to $29.46. Last Friday, it pulled back to test the prior low, undercut it by a nickel, then lifted. This is proving to be an area of support until it gets broken, which offers a well-defined zone for a trade on the long side.

If you’re expecting a shake-up sooner than later, rather than hoping for a big selloff, you could simply hedge by getting long volatility. It may be the best protection for a sudden pullback or simply the arrival of a long-awaited change of character.

DISCLOSURE:

Jeff White is long TVIX and VXX.