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Trading the Fiscal Cliff Part 1: Volatility Plays

With the potential “fiscal cliff” that’s been featured in major media channels capturing the world’s attention, it’s a good idea to develop a trading plan based on this market-moving

With the potential “fiscal cliff” that’s been featured in major media channels capturing the world’s attention, it’s a good idea to develop a trading plan based on this market-moving event.  Like an economic report, election, or other major economic phenomenon, markets will react to to this upcoming several weeks’ ahead of political actions, and traders should be prepared.

The main strategy involves several steps: a) determining what’s most likely to move as a reaction to the “fiscal cliff” phenomenon, regardless of what the ultimate outcome is b) setting up key support/resistance levels based on this, and c) developing a specific trading plan designed to capture large moves in the most-volatile instruments being traded.   This is geared towards the last couple of weeks in December, 2012 and first two weeks in January, 2013.

Like many market-moving events, there’s typically several key mini-trends, including: anticipatory trend before news is announced, knee-jerk reaction move after news is announced, then the third trend (which often becomes the dominant, major trend), after this reactionary move.

Trading Key Support and Resistance Levels in the NASDAQ and S&P

Taking a look at the NASDAQ composite chart (Figure 1), it’s evident that “obvious” near term support is at 2960, and resistance at 3030.  Looking at the most recent 7 candles on this 90-day chart shows those to be the key immediate support/resistance levels.  Major support is down near 2810, and major resistance at near 3110.

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From a trading standpoint, it’s important to stand clear and not overtrade while the market’s inside the key support/resistance levels.  Fighting the temptation to overtrade and instead, waiting until a strong trend has developed, is a more professional approach.  Once the market breaks support/resistance levels, then traders are equipped with the knowledge they need to make informed trading decisions.

Swing and Day Trading the Markets Using Exchange-Traded Funds (ETFs)

Trading major ETFs is one way to play the broader markets (or sectors, or commodities, or currencies), without needing to cherry-pick individual instruments.  For example, if the NASDAQ market sells off, there’s instruments like the ProShares UltraShort QQQ (QID) (Figure 2) that can be traded to the long side, to capitalize on short-term market drops.  Trading these inverse ETFs in case of a market selloff can provide excellent potential trading opportunities, if traded carefully and thoughtfully.

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Conversely, if the market rallies, then long instruments like the PowerShares QQQ Trust Series 1 (QQQ), SPDR S&P 500 ETF Trust (SPY) and others can be traded to the long side, to capture moves in the broad markets. Either way, having a specific market-focused trading approach that’s tied to market-specific ETFs can be a valuable strategy.

Trading Oil and Gold Plays with Stocks and ETFs

When broad markets move, another favorite way to capitalize on major trends is by trading volatile instruments related to oil and gold.  For example to trade gold, traders can trade the SPDR Gold Trust (GLD) exchange traded fund, Barrick Gold Corp. (ABX), Newmont Mining Corp. (NEM) and others.  To trade on oil volatility following a fiscal-cliff news release, oil-sector instruments such as exchange-traded note iPath Goldman Sachs Crude Oil Total Return Index ETN (OIL), United States Oil Fund LP (USO), and equities like Chevron Corp. (CVX), Exxon Mobile Corp. (XOM) are available.

Good traders know that markets are interrelated, and being at least aware of “what’s oil, gold, the US dollar, and the broad markets doing” leading into the fiscal-cliff event, and following it, makes a lot of sense.

The US Dollar and the Fiscal Cliff: Currency Plays

Forex traders can directly trade the US Dollar against other major world currencies, including pairs such as the EUR/USD, GBP/USD, USD/CAD, and USD/JPY. These pairs will likely be very volatile as progress (or lack thereof) related to the US “fiscal cliff” unfolds during the upcoming weeks, and can make for especially volatile entries and exits.

Whether scalping or looking for short- to intermediate-term swing trading opportunities, the fiscal cliff will be a currency-moving event that centers on those currencies trading against the US dollar.  Setting up a series of support/resistance levels outside of current immediate trading ranges can be valuable for this approach, as with trading other instruments.

The Banking and Finance Sector, with the Fiscal Cliff
Keep an eye on the financial sector as well: major S&Ls, banks, credit services and other sectors that are directly impacted by fiscal-cliff are economically sensitive and likely to make major moves, outpacing for example other sectors like retail and semiconductors, in their selloffs (or rallies, depending on the outcome of fiscal-cliff political progress).

One lesson learned in many volatility-based trading plays is to never underestimate just how far something can drop before recovering, if it does.  Guessing at bottoms for pivot plays is not usually a good idea; it’s best to trade in-trend directional moves following fiscal cliff news releases.  Just remember that there’s often a knee-jerk “reactionary” (often short-lived) move, prior to more robust major trend that develops.

Trading the “fiscal cliff” is something every active trader can consider developing a trading plan for, because of the potential to make major volatile moves in the markets happen, during the weeks ahead.

Ken Calhoun is a trading professional who has traded millions of dollars of equities since the 1990s, and is the producer of multiple award-winning trading courses and video-based training systems for active traders.  He is a UCLA alumnus and is the founder of and, popular online educational sites that reach tens of thousands of active traders worldwide.   ###

Copper, base metals, and industrial commodities face bearish technical trends, but the fundamentals remain bullish.