The coronavirus is spreading and reaching more and more countries and people. But what does that have to do with the stock exchanges and the latest mini-crash?
Coronavirus and financial markets?
The connection is relatively simple: on one hand, the panic on the markets leads to falling prices, and on the other hand, the situation also has a major influence on companies and economic relations. For example, important trade fairs are canceled, flights are canceled, the tourism industry suffers and companies temporarily close. All of this has a huge negative impact on the financial markets and shareholders, and commodity traders sell. This sale is very disorderly in an environment driven by fear and panic, and the volatility in the markets increases sharply.
An indicator of the level of panic and anxiety in the market is CNN’s Fear and Greed Index:
As you can see, we have reached the bottom of the chart, which is extreme fear. In most cases, this is a pretty good time to start buying again.
Was it really a mini-crash?
Let us first clarify whether this is really a mini-crash. The easiest way to do this is to look at some impressive charts.
S&P 500 drops almost 16% in just 7 days:
DAX falls almost 16% in just 8 days:
VIX rises over 200% in just 7 days:
All the examples shown leave no doubt that we are dealing with a mini-crash due to the coronavirus outbreak. There have been very few spots in the history of the stock market where the market fell by more than 15% in just 7 trading days. It is therefore not surprising that the VIX, which measures the volatility of options on stocks from the S&P 500, shot through the roof in no time.
How can you use the current situation?
In our opinion, the current panic caused by the coronavirus can be used quite well in 3 different ways and one should see the strong setbacks as an opportunity.
If you already have a stock of shares and therefore a coherent portfolio, you can use the current situation to buy more. To do this it is, of course, essential that you hold cash. Basically, you should always have a certain amount of cash. If such a situation arises, then it is important not to use all of the cash directly for additional purchases.
A good practice is to use 1/3 of the cash for additional purchases when the prices have dropped 15%. Another third could be used when a 22% loss in price is achieved and the last third when a 30% loss in price is achieved.
Purchase of unaffected shares
Another interesting approach is to look for stocks that have been taken into custody but are actually not affected by the coronavirus. It goes without saying that productive companies that do a lot of trading and work with a lot of staff are severely affected. The situation is different for companies that are not dependent on personnel, raw materials or trade. Primarily real estate companies are to be mentioned here. In addition, everyone can think a little about which companies were unjustly punished.
A third variant is the sale of current high volatility. In our opinion, this approach can only be taken on by very advanced traders.
As a prime example, you can directly sell (shorten) a volatility index (mostly an ETF). Alternatively, you can sell call options to the respective volatility index with the necessary knowledge of options and collect the premium as a writer.
Volatility indices rise extremely rapidly in panic phases and cannot last for long.
In the following, you will see, in addition to the VIX shown above, two other known values with which you can trade volatility.
The increases in these ETFs are huge and comparable to the mini-crashes in February and December 2018. Pin us down on it, but these price levels will not exist in the long run 😉