Dick Arms has spent nearly half a century following, trading and writing about Stock Markets. Best known for his Arms Index, or TRIN, his other major contributions to Wall Street methodology include Equivolume Charting, Ease of Movement, Volume Adjusted moving averages, Volume Cyclicality, and a number of volume based indicators. Reproduced here with permission of author.
Certainly it was a very sharp decline, the second worst week of the year, but it comes after the second best week of the year, and is indicative of the extremely nervous market we are in. The swings in the markets ever since the big slide began in early August have recently become almost commonplace. In fact, I am bothered by the fact that the politicians and media seem to be on a crusade to inform us of just how volatile the markets have been. The implication is that it is unprecedented, and somehow improvised by the villains that occupy the financial centers of America. One gets the impression that the next move will be an attempt to have further government intrusion in the markets. Yet it would seem that the observation about the unique volatility that is being blamed on the bad boys and girls of Wall Street is being generated by the very people who are doing the crusading; the politicians and the press.
But it is not unique! Big volatility is a valid market tool and a valid observation, but it has always been with us. Volatility represents, for the astute, an opportunity not a detriment. Big volatility comes into markets when the emotions are running high. When traders and investors are particularly afraid they tend to produce a volatile market. But fear is a valid and common emotion. The gazelle that smells the presence of a lion feels fear and flees. But he is not doing something unusual nor is he necessarily acting stupidly. The flight instinct is built into all of us. But long after the lion is left far behind, the gazelles that got the message without sensing the lion continue to run. The less fearful stop and graze. Carrying the analogy to the stock market, there are times to stop and graze when the majority of the gazelles are still running for the hills.
On the chart below we see the volatility, the upper red line, as measured using the APC, the Absolute Percent Change. Key here is the word Percent. The calculation is merely the ten-day moving average of the daily change in the Dow Industrials, regardless of the direction of change. But it is then divided by the level of the Dow, so that it does not matter whether we are looking at a Dow at 1200 or 12000, the change is observable within that context. Here we see that the volatility was, early in August, at a very high level compared to the prior two years. There was a big spike in volatility on the market low in mid-2010, but not as big as what happened recently. But please be sure to observe that the volatility invariably was higher on market lows than on market highs. In other words, fear is a much more disturbing emotion than is greed.
Just looking at this one would find validity to the recent complaints. But that is not the whole story. Lets, on the next chart, look at a really long-term picture:
Here, again the red line is the APC, but now we are going all the way back to 1970, more than forty years. I have inserted a blue horizontal line to show where we were a few weeks ago, at the top of the spike. Hey! There have been times in history when the current volatility was child’s-play by comparison. As recently as the market lows in 2008 we saw much more volatility. Perhaps the critics could blame that too on manipulation, but what about 1998 or 1987? Going back further we do not see quite such extreme readings, but remember that the period from the early eighties to the late nineties was a huge secular bull market, punctuated by only one period of extreme fear, and that was the aforementioned 1987.
My point is that the volatility in early August, and the still high volatility we are seeing now, are not unique. They are, in fact, normal and informative. The spike in early August told us the fear was overdone. The gazelles were panicking. It was a time to go against the crowd. Some grazing should have been quite nourishing. And it did not justify the government coming in and building a huge lion-proof fence around the gazelles. They would soon starve and so would the lions.
A Weak Week But Not Unique
Richard W. Arms Jr. September 26, 2011
Dick has received many of the highest awards in Technical Analysis, including the Market Technicians Association award for lifetime achievement. He has been inducted into the Traders Hall of Fame. Located in Albuquerque, New Mexico, Dick advises a select group of institutions with his weekly letter and personal consultation package, priced at $8000 per year.