When the markets are jittery (as they are now), we often see “market randomness”, or activity that is very hard to explain. Market randomness is one of the reasons you hear me say that the markets are intent on making people look foolish. This is especially true for market timers who are notoriously bad record at correctly predicting outcomes.
The best chance you have to trade successfully is examine price action, determine the trend and trust the high probability that human behavior will repeat. Tools that are based on historical evidence and high reliability can serve as your guide – but they are no guarantee. Even in the world of fundamental analysis there are no certainties, so let’s look at how to manage your trades under the current jittery conditions.
How to trade market randomness
In short, don’t think about it too much. Let’s use two case studies to illustrate why it’s so important to follow the market action.
Last week, Netflix rose up like a phoenix from the ashes to tag an all-time high. The stock flew higher on robust volume, but why? The new partnership with Barack and Michelle Obama? I sincerely doubt that announcement drove such a strong performance.
The options market portrayed a very bright picture. When Netflix was trading at 332 on Tuesday, I noticed a 350 strike call expiring on May 25 was purchased 300 times at .22. With three days to go, this option had a 7% probability of finishing in the money – very poor by any measure. Yet, by Thursday the stock had rushed past 350 and the option traded up to 3.50, a stunning 1,500% gain in just a couple of sessions.
Netflix may seem to be an anomaly, but this kind of market randomness happens more than you think. If you’re busy trying to time the markets, you will miss out on opportunities like this.
Here’s a second case study for you. Bond yields fell sharply last week, with the the 10-year dropping from 3.1% to 2.93%. With some inflation in the system and the Fed and other traders distributing bonds into the markets, the drop didn’t make much sense. But it happened, and bond buyers made out nicely.
So yes, markets do their thing and often there’s no rational explanation, just random activity. Without a reason to explain a move, many traders are driven batty – the “need to know” is too strong. Down the road, we may find the true reason for a price movement, but by then it’s too late. You must be able to identify a change in direction when it’s happening and act upon it (or not).
Again, don’t think about it too much. Use good technical analysis to read the charts – it’s the only way to successfully trade market randomness.