One Crazy Week In The Stock Market

U.S. stocks had another volatile day of trading Friday, capping off one of the wildest weeks for the market in years.

The S&P 500 and the Dow made a huge comeback Friday afternoon, but the indices still experience their most volatile week since October 2008. Once the dust settled on the week, the Dow had traveled more than 20,000 points, according to CNBC.

The Dow closed Friday around 24,100 and the S&P 500 closed around 2,619.

Know What You Own

The consensus opinion among market experts is that investors shouldn’t panic after being blindsided by the sell-off.

“The economy is doing better now than it has any time in the past decade,” Bankrate.com Chief Financial Analyst Greg McBride said Thursday. “This is just some healthy, and overdue, volatility to wring out any excess.”

Unfortunately, Stifel chief economist Lindsey Piegza said “stay calm” doesn’t provide much comfort for investors who took huge hits this week.

“From a longer-term view, or arguably a more level-headed perspective, advisors recommend knowing what you own and the reasons behind it, period,” Piegza said.

Related Link: Correction Territory: Putting It Into Perspective

Inverse Volatility Loop

So where were all the selling pressure and wild market swings coming from? Inverse volatility funds, including the Credit Suisse AG – VelocityShares Daily Inverse VIX Short Term ETN XIV and the ProShares Trust II SVXY, have taken much of the blame for the historical spike in stock market volatility this week.

These inverse volatility ETNs are designed to be reverse-levered to the VIX volatility index. This leverage creates a unique situation where the assets under management of the funds decrease as the VIX rises. As the value of the VIX contracts being shorted increases, the fund also becomes “more short” the VIX, a phenomenon that must be offset by reducing short holdings, which once again involves buying underlying VIX futures contracts.

“This buying pushes the volatility higher still, reducing AUM further, and making the issuer's hedging portfolio notionally more short, inducing further VIX futures buying to resize the portfolio to shrinking AUM,” Bernstein analyst Noah Weisberger said Thursday.

In fact, things got so far out of control during Monday's after-hours trading session that the XIV dropped 80 percent from its previous day’s close, triggering an “acceleration event” that prompted Credit Suisse to liquidate the fund.

Rising Bond Yields

The other major culprit this week was rising bond yields.

"The bond market has definitely got the stock market's attention," said Ryan Detrick, senior market strategist at LPL Financial. "Is the bond market telling us something we don't know? Is there more inflation down the road than we're expecting?"

Gorilla Trades strategist Ken Berman said the Federal Reserve has kept interest rates so low for so long that it has created some imbalances in the market.

“The tough part of this market decline is that it has occurred against the backdrop of a strong government jobs report on Friday, which showed 200,000 new jobs,” Burns said Friday.

Silver Linings

Despite the major sell-off, there were still some silver linings for traders this week. Dennis Dick, co-host of PreMarket Prep, said traders using the right strategies made a lot of money this week. Days of extreme volatility often create short-term divergence among highly correlated stocks, Dick said.

“These are your best days as relationship traders, because they're throwing everything everywhere,” Dick said.

Brokers also had a great week.

“Friday [Feb. 2] was the second busiest trading day in Fidelity’s history, and Monday was THE busiest trading day ever,” Robert Beauregard, director of public relations at Fidelity Investments, told Benzinga in an email.

Robinhood and TD Ameritrade Holding Corp. AMTD also had big weeks.

Related Link: Analyst Explains The Inverse Volatility Fund Feedback Loop

Price Action

Here’s a rundown of how the market finished this crazy week:

• SPDR S&P 500 ETF Trust SPY was down 5 percent.
• SPDR Dow Jones Industrial Average ETF DIA was down 5 percent.
• PowerShares QQQ Trust, Series 1 (ETF) QQQ was down 5 percent.
• iPath S&P 500 VIX Short Term Futures TM ETN VXX was up 48.8 percent
• SPDR Gold Trust (ETF) GLD was down 1.2 percent.
• iShares Barclays 20+ Yr Treas.Bond (ETF) TLT was down 1.3 percent.