Suspicion Asleep

You have probably noticed it already: stock market volatility has recently all but disappeared. This raises an important question for every investor: Has the market established a permanent plateau of low volatility, or is the current period of low volatility just the calm before the storm?

 

All quiet on the VIX front… what can possibly happen? [PT] – click to enlarge.

 

When such questions regarding future market trends arise, it is often worthwhile to examine market history.

For the purpose of analyzing volatility I have used one of the longest time series available, namely the Dow Jones Industrial Average (DJIA) from 1915 onward – which represents more than a century of price history. In order to improve comparability, I have removed Saturdays, which used to be trading days in the distant past. I have calculated historical volatility as rolling and overlapping time periods of 21 trading days (equal to approximately one calendar month).

 

By the Standards of the Past 100 Years Volatility is Extremely Low

On August 7 volatility measured in this way had declined to just 3.99 percent, which is a very low level indeed. By way of comparison, over the entire period of 25,734 days, volatility amounted to 15.05 percent on average!

However, this isn’t the first time it stood below the level of 4 percent. Occasionally this has already happened in the past as well, for instance in 1944, 1964/65, 2011/12 and 2014.

The chart below shows the rolling 21-day volatility of the DJIA since 1915:

 

Dow Jones Industrial Average, 21-day volatility, 1915 to 2017. Volatility is currently extremely low.

 

Volatility Can Easily Reach Much Higher Levels

Levels of volatility as low as they are currently nevertheless are very rare occurrences. Over the past century levels below 4 percent were recorded in just 0.17% of all cases. Conversely, the upside potential is considerable. To merely revert to the long-term mean of 15.05 percent would require more than a tripling from current levels.

However, historical peak levels in volatility were much higher than the average: thus in 2.99 percent of all cases volatility reached levels above 50 percent, and in 0.1 percents of all cases it even exceeded 100 percent!

The next chart illustrates the distribution of 21-day volatility levels of four percent and higher in the DJIA from 1915 to 2017 in one percentage point increments.

 

Dow Jones Industrial Average, volatility distribution, 1915 to 2017. There is substantial potential for volatility to expand – click to enlarge.

 

Once again it can be seen quite clearly how extraordinarily low 21-day volatility levels below 4 percent are.

 

Volatility in the Course of the Year

When should a surge in volatility be expected though? In order to find this out, we will examine the seasonal pattern. The next chart shows the seasonal trends in the 21-day volatility of the DJIA over the entire time period under investigation from 1915 onward.

Note: While in the first chart above I have marked out the level of volatility at the end of the respective 21-day rolling time periods (as is usual practice), I have marked them out in the middle of the respective time periods in the chart below, as this shows the seasonal pattern more clearly.

 

Volatility of the Dow Jones Industrial Average, seasonal pattern, 1915 to 2017. Apeak in price volatility is typically reached in October

 

Despite the very long time period under examination with its multitude of data points, there evidently exists a very distinct seasonal pattern in stock market volatility.

In July the proverbial summer doldrums can be observed, with volatility levels averaging less than 14 percent. Thereafter volatility typically increases to a peak of almost 19 percent in October.

 

Low volatility is not going to persist forever!

Many investors are currently betting on a further decline in volatility. In view of its already very low level and the negligible additional downside potential it offers relative to the substantial upside potential, this is probably not the best idea ever. Moreover, as shown above, October is the month in which volatility typically reaches a seasonal peak. Taking both of these facts into account, it seems far more sensible to expect an expansion in volatility.

As an aside: seasonal patterns are currently barely used by traders in volatility-related instruments and their options. You stand to gain an edge over competitors by using seasonality as an input for investment decisions with respect to all financial instruments you trade. Visit www.seasonalcharts.com, or call up Seasonax on your Bloomberg professional terminal by typing in “APPS SEASON”, or access it via the App Studio in the menu of Thomson-Reuters Eikon. There you will find precise seasonal charts, event studies and much more.

PS: it is probably the calm before the storm!

 

That dreaded moment when it suddenly becomes too quiet… [PT]

 

Charts by Stockcharts, Seasonax

 

Image captions by PT where indicated

 

Dimitri Speckspecializes in pattern recognition and trading systems development. He is the founder of Seasonax, the company which created the Seasonax app for the Bloomberg and Thomson-Reuters systems. He also publishes the website www.SeasonalCharts.com, which features selected seasonal charts for interested investors free of charge. In his book The Gold Cartel (published by Palgrave Macmillan), Dimitri provides a unique perspective on the history of gold price manipulation, government intervention in markets and the vast credit excesses of recent decades. His ground-breaking work on intraday patterns in gold prices was inter alia used by financial supervisors to gather evidence on the manipulation of the now defunct gold and silver fix method in London. His Stay-C commodities trading strategy won several awards in Europe; it was the best-performing quantitative commodities fund ever listed on a German exchange. For detailed information on the Seasonax app click here (n.b., subscriptions through Acting Man qualify for a special discount).

 

 

 

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Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

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