The past week of trading has been a little erratic and wild. It’s not necessarily the “Equities Gone Wild” of 2000-2002 when the market was ferociously volatile, but this past week does have an aura of its own that has a comparable volatility. As I was thinking about the large swings in the market, I started to compare the average daily trading range in my head. When I got home, I decided to do a little more digging to see what I could come up with and here it is.
I dug up the daily S&P numbers from 1990 and plotted the daily average trading range, the S&P’s closing average and the daily average trading range as a percentage of the S&P closing average. What I gathered was a simple volatility measure of the trading ranges throughout the year by taking the daily average trading range and dividing it by the closing average of the S&P. Essentially; I have calculated how volatile the trading ranges are in relation to the S&P market level. By plotting the range as a percentage of the closing average, I was able to see which years were the most volatile. To no surprise, 2000-2002 were the three most volatile years after a considerable run-up from 1995-1999, yet 2000-2002 were also the three worst market performance years since 1990.
click on the chart to enlarge
By viewing the table above, you can see that as the market rose from 1995-1999 volatility (as well as the average trading range) slowly increased before the market fell drastically in 2000-2002 where volatility (and the average trading range) continued to increase. It is this increase in volatility during weak periods that is interesting.
In 2000, the daily average trading range was the highest on record since 1990 at 26.08 points or approximately 1.83% of the S&P closing average. That is comparable to the past six trading days which combined have the highest daily average trading range and the second highest range as a percentage of the S&P closing average (1.88%). Although a small sample (6 days, compared to 200+), it shows that the past week has been extremely volatile by historical standards. If this past week bears anything on the future, we may see a more volatile market and a lot of opportunities to profit.
The question is whether this is an oddity or a change in trend. Is the market more volatile in bearish market conditions than bullish conditions? Why? The CBOE Volatility Index (VIX) would suggest that is the case as does the measure I calculated. The reason for the increased volatility in bearish markets is most likely due to a higher “risk” factor (fear) or lack of complacency. During these times, investors are slightly more tense and “trigger happy”; therefore, markets tend to swing in larger ranges (as suggested by the data).
What I don’t understand, and maybe you do, is why there was a significant increase in volatility from 1994-1999 while the market was moving to all-time highs compared to falling volatility during 2003-2006 when the market was continuing to make its way toward those multi-year highs? It’s as if the tandem broke at some point during the dotcom crash. (see chart below) It could have been a change in fundamentals, or it could have been a change in the way investors view the market and its risks. It’s as if we said, “Whoa buddy, not so fast. Let’s take this one nice and slow”. Quite possibly the market has become more efficient and has been able to learn from its past mistakes of jumping the gun. I don’t know if I have come to any conclusions on what it means, but it is something that I am sure I will come back to in due time, so keep checking in for new developments and thoughts. Any of your comments on this subject are appreciated.
click on the chart to enlarge
Parrot Trading Partners, LLC