Strange market reversal rumored to be sparked by a large hedge fund covering positions

2010-02-05

 

Stock market lesson:

Thursdays and Fridays traders tend to pressure the market lower, especially during periods of heightened macro uncertainty, because game-changing events can occur over the weekend.  When the market reacts negatively to benign economic or other news -- especially on a Friday due to the 'weekend fear' effect -- it may be a good idea to consider increasing net long exposure to the market.

How to invest:

These can be good times to 'upgrade' your portfolio now that the blue chip company you have been wanting to add to your portfolio finally trades at a reasonable valuation multiple.  Also, look for companies with relatively lower macro exposure.  It is important to remember that all companies have a certain level of exposure though.  Given the incremental risk, increasing exposure can be made easier when it comes along with some catastrophe protection, e.g., by buying short-term out of the money index puts.

Despite a surprising decline in the rate of unemployment from 10.0% to 9.7%, there was a lack of news to provide support to the market.  Given the uncertain economic environment surrounding Greece and the risk to the rest of the Euro zone and any potential further contagion effects, traders naturally opted to cash out of the market and wait out the weekend.  Thursdays and Fridays are traditionally easy days for short traders to pile into the market and capitalize on buyers' fears because of this 'weekend fear' effect, and this Friday was no different.  The Dow was down 170 points until 1:45PM, at which point it is rumored that one of the large hedge funds started covering all positions.  Once brokers caught whiff of what was going on, they started telling their clients to cover as well and the frenzy fed onto itself.  The market remarkably reversed all the way back to green territory by the end of the day.  It can be especially frustrating and disappointing to investors when the market is proven to be so fickle.

 

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