Markets have been shaky for the past several weeks and I have been positioned accordingly, by limiting the amount of risk I’m holding in my portfolio.
For members that attended my Master’s Club trading session at the start of this past week, I discussed why this week’s trading environment would be no different and could actually fall victim to even greater volatility, due to an event known as Quadruple Witching.
Today, I am going to present visual proof that shows the market’s tendency to be volatile during the week of Quadruple Witching and I am going to share with you my Bullseye stock of the week, which has largely been ignoring the broader market weakness.
What is Quadruple Witching?
Quadruple Witching occurs when four different types of derivative instruments (stock index futures, stock index options, stock options, and single stock futures) reach their final trading day at the same time, on the same day.
The day?
On the third Friday of the final month of each quarter (March, June, September, and December).
Essentially, what occurs during the week leading up to this event is that many investors attempt to unwind their futures and options positions before the contracts expire.
Although the effect that this confluence of expirations has on the broader market is usually not extreme, the increased volatility can be seen in the CBOE Volatility Index (VIX).
I’ve highlighted this on Figure 1 below, which shows how the VIX has maintained an upward bias during all three of this year’s quarterly Quadruple Witching weeks so far.
On this chat, each arrow points to the week of Quadruple Witching.
Figure 1
Now, when I see the potential for increased market volatility as I did coming into this week, I usually like to cut my position sizes in half.
Here’s an example:
Let’s say that I usually trade with a position size of $1000 during stable market conditions that cause my position to swing by 5% in either direction on a normal market day.
Well, if I am expecting volatility to increase, those 5% swings might become 10% swings.
Since that’s a little too volatile for my taste, my plan during these elevated volatility environments is to reduce my usual $1000 positions to $500.
That’s how I stay active in the market during unstable periods, instead of avoiding buying stocks altogether.
When it comes to stock selection, I pay particular attention to stocks that are showing strength vs. the market, and that’s what I am seeing in my Bullseye stock of the week, Arista Networks, Inc (ANET).
According to Yahoo Finance, Arista Networks, Inc. develops, markets, and sells cloud networking solutions in the Americas, Europe, the Middle East, Africa, and the Asia-Pacific. Arista Networks, Inc. was incorporated in 2004 and is headquartered in Santa Clara, California.
ANET is one of the few stocks I have found in the tech sector that has been able to withstand the onslaught of selling recently.
Figure 2
But ANET has not closed higher than the breakout level, so I’m not so sure we are going to get the explosive upside that I want out of this trade.
Why did I want to get into this trade in the first place?
ANET had a great earnings report back on November 1st and has been on my radar since then as it has been consolidating above support and regaining momentum.
If this continues, I think ANET could rise to near $140 in the next couple of weeks on the upside.
If the stock slips, I will keep $125 as my stop on it (not $120!).
Why am I so adamant about keeping $125 as my stop level?
Because at the core of my trading plan is a method of finding support that has contributed significantly to my success.
Here’s how it works:
No matter what timeframe I am looking at, whether it be a daily or a weekly chart, I simply look back to the last 3 candles on the chart and use that information to construct my support.
You can see this illustrated in Figure 3 below, where I’ve counted back 3 weekly candles to identify the open of that candle to be around $130 and the close to be around $125.
With this information, I know that the stock’s current position above $130 means that it has bullish momentum, while the $125 level is important enough for me to use as support (i.e., the stop-out level) for this trade.
Figure 3
Weekly charts are good for this method of analysis because they help to smooth out the noise that can occur on the lower time frame charts.
After presenting all of this evidence, I laid out my trade plan in the following easily digestible manner:
My Trade Plan:
- Target Price: $140
- Stop Price: $125
My Trade:
- Higher-risk “spicy” idea: ANET Dec 23 2021 132.5 Call near $1.80
- More conservative idea: ANET Dec 23 2021 125 Call near $6.50
Conclusion
While it can sometimes be scary, increased volatility is the lifeblood of traders because it increases the potential for trading opportunities in both directions.
Don’t run away from volatility, embrace it! Before you embrace it, however, be sure to have a plan in place. That plan for me this week was to identify a stock that has been showing strength, then apply a tried-and-true method of establishing a strong stop-out level and sticking to that stop-out level.
To YOUR Success!
