[Our longtime friend Tom McCafferty, a veteran commodity trader and author of numerous books on the subject, knows a thing or two about making hay when stocks and commodities turn volatile. In the essay below, he explains why the markets have been so nervous lately.  Fortunately, in the violent swings that have been occurring from day to day and week to week, he sees the trading opportunities of a lifetime. RA]

Recently, Rick did some of that great technical analysis he is known for, and after he studied the formation the bones made on his sacred cloth and cut open a few toads to check their entrails, he came to the conclusion that the Dow Industrial Average is headed for a bull rally.  Next we took a look at the fundamentals – the European banking situation, upheaval in Africa, labor problems and loss of competitive edge in China, the U. S. job and housing markets—and we grew very bearish.  In other word, today’s Market is like a Joyce poem: you can read into it just about whatever you want.

We become further confused when we see so many strong companies sitting on tens of billions of dollars, and, at the same time, they are laying off staff.  With their fat bankbooks, there are just too many of them striving to get leaner and meaner.  On top of that, quarterly earnings are pretty damned good.  We needed a good reason for this behavior.

Then it dawned on us.  It was so simple we were embarrassed.  The whole world is suffering for a “Compliancy Complex.”  You will not find that dysfunction described in any medical textbook, but we know in our heart of hearts what it is.  There is just too much unexplainable information overwhelming us at one time, to wit:

•           The Arab Summer of Discontent

•           The most bitter infighting in the U. S. Congress since the Revolution

•           Africa starving itself to death

•           Banks and countries around the world on the verge of bankruptcy

•           Labor and unemployment problems almost universally

•           The most volatile stock market on record

•           Even China feels the pinch of inflation, worker unrest and losing market share

Sensing all of this turmoil, would you, as the CEO of a major corporation with a ton of cash on hand, a product that is still in demand and a workforce fearing the next round of layoffs, start hiring willy-nilly?  Or would you strive to get leaner and meaner to weather this tornado of bad news?  It is time to make key acquisitions, to lock up any natural resources vital to the growth of your business and to prepare to attack at the first sign of fair weather.

Unmatchable Rewards

This explains the “Compliancy Complex” and spawns many of the volatile market moves.  Every once in a while, the Market thinks it sees a light at the end of the tunnel and runs prices up in the double digits.  Then it realizes that the light it sees is the headlight of a train bearing down on it at a high speed, precipitating a brutal reversal.

How do you trade these markets?  The only answer is with tight discipline.  Just as most traders have entry points, you must also have a firm exit strategy.  Using stop-losses also is advised.  Also pay attention to key pivot points when you know the Market will react violently.  Many of these are telegraphed in advance.  For example, when the S&P told the Market in advance that it was considering downgrading U.S. bonds, you had to know that a big move was coming.   If they did, the Market would tumble.  If they did not, it would probably spike.  That’s when you put a strangle or straddle  position on.

This is a key period in the history of the Market.  It is time of great risk and unmatchable reward.  The patient, disciplined trader will come out this with his or her personal island in the Caribbean.

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