Market Selloff: Strike While the Iron Is Hot!

I don’t usually drink on a Monday afternoon, but yesterday, I made an exception. Once the market had closed, I snuck out of the office for a cold beer (a Shiner Bock, of course). And then I ordered a second one. It had been that kind of day.

But here’s the thing: while wild market volatility is nerve wracking, these are the days when the best opportunities present themselves. I’m not exaggerating when I say that I made 30% in about 15 minutes yesterday, and I did so while taking no risk whatsoever.

I got lucky. I happened to stumble into a mispriced security, and I struck while the iron was hot.

Let me give you the details. I opened my trading screen to find that an ETF I owned, the Cambria Shareholder Yield ETF (NYSEARCA: SYLD) had dropped by 50% in value. It had lost half its value from Friday’s close. This is what I saw:

SYLD

Remember, ETFs are not stocks. They are exchange-traded mutual funds that, by their very construction, are supposed to follow an index. At least in theory. If they didn’t, large institutional investors could buy up a large block of ETF shares, break them apart into their portfolio holdings, and then sell the portfolio holdings in the open market for a risk-free profit.

In the case of SYLD, we had a mispricing that was theoretically impossible. The ETF’s price was down by 50%… while the actual portfolio of stocks that SYLD tracks were down maybe 4% at most.

But on a trading day like yesterday, you don’t have a normal, functioning market. You get mispricings like these. (SYLD wasn’t the only ETF whose pricing became untethered from reality. It’s just the only one I happened to be trading at the time.)

So, I did what any rational investor would do: I plowed every dollar I could find into SYLD shares before the mispricing window closed. I made about 30% in 15 minutes, sold the shares and went on about my day.

I tell this story not to toot my own horn. I’m the first to admit that I got phenomenally lucky here. But there are definitely some lessons we can learn from this:

  1. To start, ETFs are illiquid, and have low trading volume. You can’t dump a bunch of shares without affecting its price. So when a large shareholder unloads his or her shares in a hurry, especially on a smaller ETF like SYLD that typically trades less than 30,000 shares per day, it startles the market. Thus, you get big mispricings like we saw yesterday.
  2. But this same illiquidity can create fantastic short-term opportunities if you’re willing to take the other side of the trade and you are small and nimble enough to act. If I had been running a multi-billion-dollar hedge fund, I wouldn’t have been able to make this trade. Given the small size of the ETF, I would have moved the market, destroying the opportunity I was hoping to exploit.
  3. I was also able to jump on this because I wasn’t fully invested. I had a little dry powder… just in case. In order to take advantage of opportunities like these, you need to keep a little cash on hand.

Keep your eyes open. We’ll have more volatility in the months to come… and plenty of good short-term opportunities.

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Charles Sizemore
Editor, Dent 401k Advisor

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About Author

Charles Sizemore is a research analyst with Dent Research. His primary research focuses on income, retirement strategies and fundamentals.