My definition of a fear trade is simple to understand. Much to my frustration, it took years to understand how to respond when markets go crazy. Especially when years of gains get wiped out in a matter of weeks or days even.
If I had to sum up the response to fear, I’d fall back on the old Wall Street proverb:
“Sell strength and buy weakness”
It sounds simple because it is. But, human nature has the uncanny ability for us to make stupid decision when emotional or under stress. Ask any veteran trader and they will agree, the enemy of success is you!
Moving forward, let’s establish what make up a classic fear trade in financial markets. The idea here is to create a simple screen to quantify fear. So, when you see two or three of the following it qualifies as a fear trade in my opinion.
3 Signs of a Fear Trade
- A meaningful spike in the VIX
- NASDAQ down 5% in one day
- Crypto down 15% in one day
To summarize, fear trades are rare. If you think a genuine fear trade is unfolding when a single stock gets hammered at the open (like Netflix today) you’re missing the point. To be clear, a fear trade is a market wide event. Nobody escapes without a few bumps and bruises.
Conclusion
My definition of a fear trade is one of market wide chaos, not a single stock event. Although rare, fear trades offer investors an extraordinary opportunity to make money. Simply put, if you’re playing or investing with scared money it’s almost certain you will lose. For sure, it helps to define what fear is so you can response accordingly. That’s how professionals approach investing.
The next time a fear trade manifests itself, hopefully this post will help you gain some valuable perspective.
As a quick follow up yesterday’s post, both Lululemom and Shopify are still great mean reversion trade candidates. Although Shopify is caught up in the tech sell off, Lulu is holding firm. Check out the post, the link is below.
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Checkout my post yesterday on two possible mean reversion trades setups –>
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