The Dow Stat Pointing to New Record Highs

Blue-chip stocks could be at risk for a short-term pickup in volatility

Aug 22, 2017 at 11:35 AM
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Stocks went on a roller-coaster ride last week. Though easing geopolitical tensions helped boost markets early on, President Donald Trump's unsettling reaction to the events in Charlottesville, Virginia, and rumors of high-profile administration departure had traders fleeing riskier assets later in the week. The Dow Jones Industrial Average (DJIA) went on to log its heftiest two-week loss since the Brexit backlash in 2016. Here's closer look at how stock markets have reacted following a similar scenario for the Dow, when, combined with this rare Nasdaq signal, could be encouraging to bullish traders.

Dow's Sharp Decline Could Create Short-Term Volatility Pop

In the two weeks ended Aug. 18, the Dow shed 418 points, the most since the blue-chip index shed 465 points over a two-week time span in June 2016. Still, this drop is still relatively tame -- and is the second fewest out of all 22 other times the Dow has shed more than 400 points in two weeks since 2010, according to Schaeffer's Senior Quantitative Analyst Rocky White. Below is how the Dow has tended to perform after what we'll call a "signal," when the index loses more than 400 points in a two-week time span, though both weeks must accumulate a loss of at least 100 points.

The DJIA has historically turned in a strong showing in the aftermath of such steep losses, averaging two-week and one-month returns that more than quadruple the Dow anytime returns since 2010. And while volatility tends to pick up in the short term, per the average standard deviation readings, it tapers off at the three-month mark, even as the index boasts a post-signal average gain of 6.65% and 95.5% win rate -- much higher than the anytime three-month return of 2.6%, positive just 72% of the time. Should history repeat itself, a move of this magnitude would put the Dow north of its Aug. 8 record high of 22,179.11.

dow returns after 400 point loss

Why It's a Great Time to Buy Options

With the risk of a bigger volatility spike on the near-term horizon, Schaeffer's Senior V.P. of Research Todd Salamone noted in this week's Monday Morning Outlook that now is an ideal time to "be utilizing options as part of your overall investment strategy," considering "equity option prices have imploded recently, since many companies just reported quarterly earnings during the past three weeks." While the "purchase of calls allows you to reduce your dollars at risk relative to buying 100 shares of the stock," buying puts can help you "profit from the decline that you think could be lurking."

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