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Feature

Putting Today’s Volatility in Perspective

by

Van K. Tharp

The volatility that we’ve had in the market since last October has been so huge that I’m considering including a market type that just includes high volatility conditions. As a result, I wanted to get some perspective so I used XLQ to look at  ten thousand days of daily data in the S&P 500 going back to June 1969.

From that data, we calculated the 20 day ATR for each of the ten thousand days. In 1969 the price of the S&P 500 was under 100 and the 20 day ATR was around 1.62 points per day. In 1999, when the S&P 500 was at 1400, the 20 day ATR was about 16 points. Thus, the only way to reasonably compare the ATR for the two dates is as a percentage of the close, which we calculated for all ten thousand days. In 1969, the ATR% close was about 1.7% and in 1999 the ATR% close was about 1.2%.

When I looked at ten thousand days of data, the average ATR as a percentage of the close was 1.47 with a standard deviation of 0.72. The median ATR as a percentage of the close was 1.37. Thus, we can determine extreme moves by adding 0.72 to the mean several times. These are shown in the table below. You can see that a value 3.64 is three standard deviations from the mean and that 10 standard deviations from the mean is 8.68.

I then ranked the data from largest to smallest based upon the ATR close. The top 30 ranked days are shown in the table below.

The top thirty days are all from late 2008, with the one exception of November 1987. Furthermore, most of these days are at least six standard deviations above the mean.

Based upon these data, I decided to define market volatility as a percentage of the close with the following parameters:

• Very Volatile: At least 3 standard deviations above the mean (i.e., bigger than 3.64).

• Volatile: At least 0.5 standard deviations above the mean. (In other words, a volatile market has an ATR% close that ranged from 2.19 to 3.63).

• Normal: Within 0.5 standard deviations from the mean. (This means the ATR% close ranged from 0.75 to 2.18).

• Quiet: An ATR% close below 0.75.

The following table shows the distribution of the 10,000 days according to these criteria.

Notice that only 120 days or 1.2% of the total number of days ranked as very volatile. However, these included the following periods, shown with their ATR% close range. 

1) October 9, 2008 through November 7, 2008 (6.03-8.04)

2) October 19, 1987 through November 17, 1987 (3.69-5.99) This one started with Black Monday.

3) July 22, 2002 through August 9, 2002 (3.74-3.94)

4) September 27, 1974 through November 4, 1974 (3.60 to 3.8)

5) March 3, 2009 through March 12, 2009 (3.64-3.91)

Recent volatility has been off the charts. I don’t have data going back to the Great Depression to compare the results, but I tend to doubt that the 1929-1934 ATR% closes were worse than what we’ve just seen.

All of these periods, with the exception of the 2009 period, were associated with Market Collapses. So perhaps there is a strong relationship between volatility and bear markets, one that most people would not suspect. Let’s look at another table that shows the average daily % change in the market as a function of volatility.

I almost fell over when I saw the results. Under very volatile conditions, the average market change is about -0.3% per day. This is even stronger than when the market is classified as bearish by the direction. Even volatile conditions show a slight downward bias. In fact, the upward bias appears only in normal and quiet conditions. However, please remember that these are averages over many, many days. But the results are still amazing. Stay tuned for more soon as I continue my research.

What about today? Are we back to normal? The ATR% close values in May 2009, so far, range from 2.19 to 2.4. This still puts us in volatile territory.

However, the numbers have calmed down considerably since late last year.

Under such high volatility conditions, the best strategies have typically been very short term trading in which large daily ranges translate into potential for huge R-multiples in a short period of time, and option strategies that capture premium with very little risk.

Trend following, even on the short side, doesn’t work unless you are willing to tolerate extremely large whipsaws against you.

About Van Tharp: Trading coach, and author, Dr. Van K. Tharp is widely recognized for his best-selling books and his outstanding Peak Performance Home Study program - a highly regarded classic that is suitable for all levels of traders and investors. You can learn more about Van Tharp at www.iitm.com. 

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Trading Tip

Some Much Needed Perspective on the Current Rally
Part II

by
D.R. Barton, Jr.

Two weeks ago, we looked at the market’s strength as the S&P 500 index had its second down day (Tuesday 5/12) after what proved in hindsight to be at least a short term exhaustion top. Media hype over that run-up from the March lows was getting pretty loud. We looked at the math of bounces and some retracement lines to add some perspective. 

Today (late Tuesday night 5/26), we find ourselves within one S&P 500 point of that close two Tuesdays ago! We’ve traded down, up, down and then back up today, all with a 45 point S&P 500 range. But tellingly, we haven’t made a new high since May 8th.

Once again, I feel obligated to state that the move off of the March 6th lows has been impressive. But to paraphrase someone’s quote I can’t find using Google, “Give me 1.7 trillion dollars, and I could throw a whale of a party, too.”

I’m not convinced that this leg up is over, but I don’t think that there is much cause for rejoicing. Last week we saw that the S&P 500 had not even retraced 25% of its down move from October 2007. To throw even more water on the flames that so many pundits are trying to fan, let’s look at how the S&P has fared versus good old fashioned gold.

Ouch! That’s some ugly perspective for us to chew on: 29 years of stocks versus gold. Yes, gold has gone up in price since the market was soaring in the Internet bubble. But the retracement we witnessed over the past couple of months is barely a blip on the radar screen…

Last week I mentioned that there were five significant rallies in the Dow during the Depression’s bear market. The folks over at chartoftheday.com have put those rallies in a nifty graph showing percent rally drawn versus rally duration. They have conveniently added the current bear market rally to compare and contrast.

This chart shows the magnitude of rallies that can occur with rallies lasting almost half a year and bouncing up almost 50%. Fast six week rallies carried us up 35% back when things economic were very bleak indeed. The fact that we’ve rallied neither as far nor as fast may be disconcerting, but it also gives hope that the rally isn’t over. I’ll be looking for whether we can eclipse that May 8th high with any conviction in the next couple of weeks. If so, we could sustain this leg up for quite some time. If not, the rally is likely to die under the weight of the gaudy expectations that have been heaped upon its still unproven shoulders.

Great Trading!
D. R.

About D.R. Barton, Jr.:  A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena.  He is a regularly featured guest on both Report on Business TV, and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at  "drbarton" at "iitm.com".  

Q&A

Flawed Currency

Q: Dear Van,  I wish to thank you for your most enjoyable commentary on market types.  I found the email to be very informative. I am new to currency trading and currently studying as much as I can so that I can develop an edge towards the market before I engage with real time trading.

My interest in currencies began after reading a book called Hot Commodities by Jim Rogers. I recently heard him say on Bloomberg TV that the US dollar is a "flawed currency."

I have a lot of respect for Mr. Rogers, yet found myself scratching my head at this comment. I would be extremely grateful if you, or someone in your team could be kind enough to clarify this for me.

Best Regards, James

A: I totally understand Roger's comment. What I don't understand is how the dollar continues as a world reserve currency. 

1) The US is a bankrupt country and there is a report at the St. Louis Federal Reserve site which state this.

2) Our debt is parabolic with no end in sight.

3) Only two things keep the US alive: a. Other countries are willing to buy our debt. b. The US Dollar is still the world's reserve currency.

Keep in mind that my comments on the dollar are long term...as are Jimmy Rogers'. This probably has no impact on short term currency trading strategies.

Van

P.S. Dr. Tharp writes a monthly market condition update the first Wednesday of every month. That update always includes a section on tracking the US dollar. To review back issues go to this link: http://www.iitm.com/weekly_update_backissues.htm

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