Welcome to the ‘Volatility Vortex’

A survey of the equities landscape over the past month reveals a market riddled with gaps. Trying to find logic and order from such a chaotic scene borders on the impossible.

It�s been a volatility vortex that has battered virtually all market participants, to some degree or another. In fact, in the last month alone, the S&P 500 Index � via the SPDR S&P 500 (NYSE:SPY) — has experienced over 11 daily gaps of 1% or more � with four of them coming in over 2%. The chart below highlights all 11 instances.

Source: MachTrader

By definition, a gap occurs when a stock opens at a higher or lower price than it closed during the prior trading session. For example, the SPY closed Tuesday�s session at $120.05, yet opened on Wednesday morning at $123.49 � a gap higher of $3.44, or 2.9%.

In a normal, stable market, sizable gaps rarely occur. During such an environment, prices move in a more fluid manner — making it easier to buy and sell stocks and options at the price you want.

When volatility rears its ugly head, such as during a correction or bear market, gaps can become commonplace. In the midst of such a market, it becomes increasingly difficult to enter and exit trades at desired prices.

Stocks can often gap much higher than your anticipated entry price, or gap much lower than your expected stop-loss. So, to successfully navigate a gap-laden market, I invite you to consider the following two suggestions:

1. Sit on the sidelines. When a nasty volatility fog has settled over the market that makes it difficult to divine direction, you may want to watch from the sidelines for a little while. Keeping your powder dry until the dust settles ensures you�re able to take advantage once an easier trading environment materializes. Sometimes cash is the best position a trader can be in.

2. Trade smaller. When conditions are unfavorable, traders should reduce the size of their bets. If you�re used to risking $200 per trade, then reduce it to $100. It�s rarely a good idea to get overly aggressive when volatility rules the roost. All it takes is one large adverse gap to wipe out a large amount of hard-earned gains.

If the current bipolar market has you down in the dumps, take heart. More favorable market conditions will eventually come back. They always have and they always will. The key is to make sure you�re in a position to participate once the gravy train returns.

At the time of this writing Tyler Craig had no positions on SPY.