Whipsaw
What is Whipsaw?
Whipsaw describes the movement of a stock when, at one point, the price of the stock moves in one direction but then spins rapidly to move in the opposite direction.
There are two types of “whipsaw” patterns. The first involves an upward movement in the stock price, which is then followed by a drastic downward movement that causes the stock price to fall from its original position. The second type occurs when the price of a stock loses value for a short time, and then suddenly rises to achieve a positive gain from the stock’s original position.
KEY TIPS
Whipsaw describes the movement of stocks in a volatile market when the price of a stock suddenly changes
There is no set rule on how to handle circular saw moves in a volatile market because it is an unexpected
The boost in securities trading often results in trading losses.
Day traders expect bunny moves and often take long positions, buy and hold positions to overcome price fluctuations to avoid a loss.
Understanding Whipsaw
The origin of term whipsaw comes from the pushing and pulling action of lumberjacks when cutting wood with a saw of the same name. A trader is considered a “whipper” when the price of a stock in which he has just invested suddenly moves in the opposite and unexpected direction.
Whipsaw’s models work especially in a volatile market where price fluctuations are unpredictable. Day traders or other short-term investors are used to being whipped. Those with a long-term investing, buying and holding approach can often overcome market volatility and come out with positive gains.
For example,
When an investor takes a long position in a stock, the price is expected to increase in value over time. However, there are many occasions when an investor buys shares in a company during the height of a market rally.
The investor buys a stock at its peak assuming that it will continue to make large gains. Almost immediately after buying the stock, the company releases a quarterly report that shakes investor confidence and drops the stock’s value by more than 10%, never to recover. The investor holds the share at a loss, with no effective put option on the share.
Conversely, some investors, especially those who sell short, may face whiplash at the bottom of a market. For example, an investor may anticipate an economic downturn and buy put options on the SandP 500. The investor benefits if the market continues to fall. However, almost immediately after buying the puts, the market unexpectedly rebounds and the investor’s options quickly become “out of the money” or worthless. In this case, the whiplash occurs during a payback phase and the investor loses the investment.
Financial markets change suddenly. Many analysts look for models that explain market trends so that an investor can select the right asset classes. A study by Sonam Srivastava and Ritabrata Bhattacharyya, titled Evaluating the Building Blocks of a Dynamically Adaptive Systematic Trading Strategy, explains that stock patterns vary due to fundamental changes in macroeconomic variables, policies or regulations.
The authors specify that a trader must adapt his trading style to take advantage of the different phases of the stock markets. They also suggest that investors select asset classes in different market regimes to ensure a stable and risk-adjusted return profile. However, different experts will offer different advice.1
A false signal refers to any price movement that is in the opposite direction of a trader’s expected bet, often resulting in a loss or, if they are able, overcoming price fluctuations to keep the investment and even make a profit
Real-world example
On December 6, 2018, CNBC reported that the actions materialized when news of the deteriorating U.S.-China trade relationship and the possibility of an economic slowdown reached investors. Expert advice has varied. Resistant to volatility, one expert advised investors to choose a long-term strategy that capitalizes on their strengths and follow it regardless of whiplash moves.
In terms of investing, another expert recommended investing in more stable sectors like healthcare and avoiding more volatile sectors like real estate. Most pundits expected significant volatility in the near term, and one recommended taking a defensive stance. However, he also said that a long-term portfolio based on securities would win
