January 8, 2009, 6:00 am

Why Stock Markets Are So Volatile? The Tale of 4 Masters

by: The Financial Blogger    Category: Investment, Market and Risk
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2008 as surely been one of the toughest years on the investors’ patience. We are currently living on of the biggest period of volatility in the stock market history. For example, during 1950 to 2000, there was 27 days where the TSX moved (up or down) by more than 4%. In 2008 alone, we had 42 days like that (stats are not counting month of December). How can this be possible? Is the world about to end or is there a real explanation?



Hedge Funds – Master of Leverage

Thinking the Smith Manoeuvre is risky? Hedge funds have been increasing in size and power over the market since 2000 at an incredible rate. The problem is that they used leverage technique to its maximum.

Since all markets go down, they are forced to cover their position and pay back their loans. Unfortunately, they have to sell massive amount of shares (at loss), in order to meet their margin call requirements. This is one of the main reason why rescue value such as gold is dipping with everything else; hedge funds has to sell all their positions regardless of their original trading strategy.

Managed Portfolio – Master of asset allocation

It’s been a few years that you have the possibility of buying a well diversified portfolio that will equilibrate its positions every 6 months or so. The fund manager makes sure that he sells what went up to buy what went down and respect the original asset allocation.

For example, if you have a balanced portfolio (50% equity and 50% fixed income), your stock portion probably went down around 40% in 2008. So your equity portion went from 50% of your portfolio to 30%. Therefore, fund managers sold massively your fixed income portion (obligation and such) in order to buy more stocks and bring back the original asset allocation to 50% equity and 50% fixed income. This causes massive transaction since they had to buy so much stocks at the same time.

Stock Options – Master of disguise

Since their creation, nobody is 100% comfortable managing those weird beast. They have been created to secure investment strategy (you can cap your buying price and your selling price on a specific stock). However, they have used for the benefit of speculators and CEO’s of big companies.

This is why, every 3rd Friday of the month, you will notice a higher volatility. This is because options expire on that date. Several speculators have to cover their positions and buy or sell shares on the market.

Small Investors – Master of fear

Did you know that the mutual fund industry in Canada registered for 13G$ order of sales? This means that people massively went out of the mutual fund market, forcing fund managers to sell at a really bad timing.

There is good news!

Actually, we all know that several investors (small to institutional) have a lot of cash right now and they are all waiting. Once the market will start to go up, these people will jump (late) in the train and will put the additional push to make sure we live another bull market. This is when we will be up to the next bubble!


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Comments

Remember you asked about whether you should buy bank stocks. I think even though (US) banks started this problem, they are going to be the first ones to recover. I can feel it coming. Investors are starting to be a little less fearful and there will be some buying going on. Banks will make money off this, so probably a good time to buy a bank.

I think the clues will be in the next several financials from banks. Once they stop being reactive and actually start lending and expanding (if I recall correctly, Bank of America slashed their capital expenditure budget to $0 last year), it should be the side things are turning around.

by: The Financial Blogger | January 9th, 2009 (6:59 am)

Goalhunter,

I’m sure banks will come back! they are at the center of our economy so if they don’t come back… nothing will!

[…] Financial Blogger discusses why stock markets are so volatile. Here is a look at four aspects of the stock market: from hedge funds and managed portfolios to stock options and small investors. Now maybe these ways […]

[…] Financial Blogger explains why the markets are so volatile. […]