The Easiest Way to Take Advantage of Investor Fear
What your brain's 'fear center' has to do with investing... Stay calm when others panic... The easiest way to take advantage of investor fear... Did you tune in for our historic Melt Up Event?...
'SM' was fearless...
Researchers couldn't rattle the 44-year-old woman, no matter what they did. (She's referred to by her initials to preserve her privacy.)
They showed her scary movies and took her to a haunted house. They even exposed her to spiders and snakes. But SM was unphased. She showed no fear whatsoever.
As humans have evolved, our bodies have developed complex safety mechanisms. Deep within our brains lie two almond-shaped masses called amygdala, which help trigger a primal response to perceived threats or dangers. They're the brain's "fear center." (My colleague Dr. David "Doc" Eifrig has written many times about how the fight-or-flight response controlled by the amygdala works against investors... a "Doc insight" that one former editor in chief counts among his favorites.)
SM had lesions on her amygdala – because of a rare condition known as "lipoid proteinosis." As a result, her internal safety measures didn't work properly... Her fear center was broken.
For example, when researchers took her to an exotic pet store, SM repeatedly asked to touch one of the larger snakes, ignoring the store employee's warnings that the snake could bite her. She also attempted to touch a tarantula, whose fangs didn't scare her either.
Being fearless may sound like fun, like you could go out and conquer the world...
But fear serves a key purpose. It's a survival instinct and prompts our "fight or flight" response.
Without these protections, SM didn't hesitate to walk through a park by herself one night. And she didn't feel a burst of adrenaline when a mugger held her up at knifepoint.
Fear serves us well in everyday life, but it can be devastating for investors. In my Stansberry Alpha advisory, I (Alan Gula) show my subscribers how to use options to take advantage of investor fear and generate outsized returns.
For many investors, today's market action has their fear centers lighting up like a pinball machine... maybe yours, too. Lots of folks are thinking about fleeing the stock market.
Instead, I'd like to show you a different – even easier – way to use investor fear to your advantage. (More on that in a bit.)
Our brains are wired to keep us safe, not to make sound investment decisions...
As any investor has probably experienced, our safety mechanisms can impair our judgment in the heat of the moment. When the stock markets are falling, fear takes over.
Did you panic at any point over the past two weeks and sell some of your positions? That was because of increased activity in your amygdala, which told you to get out.
While many investors are panicking, smart investors stay patient. They don't let fear take over and scare them out of the market.
(Of course, we must stay disciplined and follow our stop losses. But we never want to indiscriminately sell our stocks because they're falling, like most investors do.)
The easiest way to tell how scared investors are at any given moment is by looking at the Volatility Index ("VIX"). The VIX is the stock market's "fear gauge." It measures the one-month expected (or "implied") volatility for the benchmark S&P 500 Index. In other words, it's the options market's expectations of how big a move the S&P 500 will see over the next month. The higher the VIX, the wider the expected range.
As I write, the VIX is above 25. That means the options market expects the S&P 500 to rise or fall by about 7.2% over the next month. With the S&P 500 trading around 2,655, the options market expects it to trade between 2,473 and 2,857. (For you math geeks, that's the one standard deviation confidence interval.)
For most of us, losing money causes more psychological pain than making money causes pleasure. That's known as "loss aversion" in behavioral economics. As a result, when the market is falling, investors are afraid of losing more money... So they're willing to pay more than they would otherwise for portfolio insurance (in the form of put options). And as fear spreads and the options market prices in wider swings in stocks, the VIX rises.
I'm no stranger to volatility...
As longtime Digest readers know, I had a front-row seat to the financial crisis on the distressed-debt desk at Barclays Capital.
From Lehman's bankruptcy to the end of 2008, the market was open for 76 trading days. On 18 of those days – nearly a quarter of the time – the S&P 500 rose or fell by 5% or more.
The VIX spent much of that period above 50, and it reached a record of 80 during those dark days.
Think back to how you felt in late 2015 and early 2016...
The markets were extremely volatile. Investors were scared, and for good reason.
Commodity prices had collapsed. Bankruptcies were mounting in the energy sector. Economic growth around the world had begun to stall. And folks were getting scared that we'd see a recession.
In early 2016, the S&P 500 suffered its worst start ever, falling more than 10% by mid-February. Emerging markets stocks were doing even worse... The MSCI Emerging Markets Index had fallen about 35% from its mid-2015 high.
Millions of investors were succumbing in unison to fear signals from their amygdala. As you can see from the following chart, that caused the VIX to soar...
Investors who got scared out of the market back then were making a huge mistake. Folks who endured the early 2016 fall without selling saw the market rise nearly 30%.
Even factoring in the pullback we've seen in recent weeks, the S&P 500 is up almost 50% since bottoming in February 2016...
Basically, higher fear and volatility provide fuel for powerful rallies. That's why the recent market turbulence is actually a blessing in disguise.
If you've been paying any attention to the markets, you know it has been a particularly volatile month. As I write, the S&P 500 is down more than 9% for October. If stocks end the month at their current level, it would be the market's worst month since February 2009. And it feels more painful than you might expect, because the average stock in the S&P 500 is down 19% from its 52-week high.
So it's no surprise that the VIX has averaged about 19 this month, and spiked to nearly 30 today.
The recent surge in volatility comes as no surprise to me or my colleague Steve Sjuggerud...
Steve has been calling for a "Melt Up" in stocks since he presented the idea on stage at our Stansberry Conference in Las Vegas back in September 2015.
He's already been proven correct as the stock market has soared higher... But he still believes that the biggest gains lie ahead.
And if this Melt Up is anything like the last one – the infamous dot-com bubble back in late 1999 and early 2000 – get ready for higher volatility. As Steve has noted, the Nasdaq fell by roughly 10% or more on five separate occasions in the final 12 months of the last Melt Up.
But remember, each of these occasions was actually a great buying opportunity, rather than a reason to sell. And Steve says that's exactly the case today.
Earlier this week, Steve hosted a free Melt Up Event where he shared his latest predictions about the Melt Up... said the recent pullback is the perfect "buy the dip" opportunity for investors... and explained why investors sitting on the sidelines are making a huge mistake. If you missed it, you're in luck... We're offering a replay of this event until Sunday morning. Watch it here.
New 52-week highs (as of 10/25/18): none.
Has the recent volatility caused you to panic and sell, or have you followed our advice? Let us know how you're faring during the market's choppiness by sending an e-mail to feedback@stansberryresearch.com.
Regards,
Alan Gula
Baltimore, Maryland
October 26, 2018