Stock prices got hammered in December, there’s no two ways about it. But let’s not forget, US equity markets stumbled out of gate at the start of the year, too.
The pop in volatility was so severe at the start of 2018 that the XIV (a short volatility ETN) actually ceased to exist in the wake of it.
The difference between the start of the year, and the end of year, is well illustrated by the number 24k in the Dow Jones Industrial Average (DJI).
Looking at a chart of the DJI, one can see that during that tumultuous period in early 2018, the index never broke below 24k. This was clearly an important level of support, and one that caught my attention at the time.
As markets started to break lower in early October (many months later), I wondered if 24k would hold, and for how long. The high in DJI for 2018 (and also all-time) was roughly 26,800, so that meant a drop to 24k would only represent about a 10% correction.
While 10% is a relatively big move, it's certainly not eye-popping as compared to some of the most severe corrections in market history.
Notably, the DJI remained above 24k through some serious market volatility in October, November, and the first half of December.
However, on December 17th, the DJI finally closed below 24k, and things got rapidly worse from there. Once the DJI broke below 24k (which remember, was only a 10% correction from the high), the index lost another 6% in just 4 days.
Counting the half-day of trading on Christmas Eve, the Dow Jones Industrial Average was suddenly down 19% from its 2018 high. Another 9% was basically lost in 4.5 trading days.
Now that’s volatility.
The DJI has sold off so dramatically that it even calls to mind a term that doesn’t get thrown around too much during “normal” trading conditions - tail risk.
Tail risk in the market refers to a form of portfolio risk which captures the “remote” probability that the value of a given investment could move by more than three standard deviations from its current value. Visualizing a “normal” bell curve of investment returns, tail risk is captured in the extreme ends of the curve - those that are supposed to be extremely low probability.
Recent moves in the DJI definitely qualify as the “tail risk” variety - especially the 4.5 days leading up to (and culminating on) Christmas Eve day.
Fortunately, a new installment of Market Measures focuses on this precise topic, and provides viewers with additional perspective on tail risk, as well as an overview of tactics traders can utilize to protect and manage their portfolios in trading environments in which tail risk probabilities are increasing.
Due to the importance of this topic (and current relevance), we hope you’ll take the time to review the complete episode of Market Measures focusing on tail risk when your schedule allows. Another episode to watch focusing on a similar theme is “Outsized Move Defense.”
If you have any questions about tail risk, or tactics you might consider when trading in trading environments that encompass elevated levels of volatility, we encourage you to leave a message in the space below, or contact us on Twitter at @tastytrade or by email at firstname.lastname@example.org.
Wishing you all a great 2019!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
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