On Thursday, we noted the increase in volatility via a Financial Post column. Today’s chart porn comes via the NYT & Barron’s.
First up, the NYT, with this gorgeous info-graphic on volatility — note the peak in 2002, which marked the bottom of the Bear markets (Oct 2002/March 2003):
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Chart courtesy of NYT
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Second, have a look at Dick Arms column in Barron’s. Dick believes the recent volatility surge is a Bullish sign.
I have a lot of respect for Dick, as his methodology is statistically based and empirically driven.
Even if you disagree with him, you can at least respect his methodology, which has zero cheerleading content in it.
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Chart courtesy of Barron’s
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Previously:
Buy Volatility (January 14, 2006)
http://bigpicture.typepad.com/comments/2006/01/buy_volatility.html
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Sources:
For Stocks, It’s the Wild West, East …
FLOYD NORRIS
NYT, March 29, 2008
http://www.nytimes.com/2008/03/29/business/29charts.html
Whiplashed? That’s a Bullish Sign
Now Is the Time to Buy, Not Sell
RICHARD W. ARMS
Barron’s, MARCH 31, 2008
http://online.barrons.com/article/SB120676003110074029.html
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If you follow the suggestion in the chart to buy at 1.5 it would say you should have been buying in 2000 and 2001. For long term investing it seems more prudent to wait until volatility has dropped below 1.0 for an extended period of time — based on only one period of course. You would miss the true bottom but avoid many false signals. Maybe it works as a trade but then you need a different graph to show volatility vs next X days gains.
The fundamental flaw in Dick Arm’s chart is the time period. Had he looked at data starting in the 1920’s, his conclusion would have been very different.
Take a look at March 18,19,20 2008 for instances: the DOW closed in the top, bottom, & top, 5th percentiles respectively. That happened 25 times since 1925. 22 of these took place in the 1930’s. Only 2 where actual bottoms. Here is the list:
1930-11-18,1931-03-09,1931-03-18,1931-05-04,
1931-06-10,1931-08-13,1931-09-25,1931-10-08,
1931-12-07,1931-12-22,1932-02-18,1932-06-14,
1932-07-27,1932-08-03,1932-09-23,1932-10-14,
1932-11-10,1933-02-28,1933-04-18,1933-04-24,
1933-07-26,1934-08-13,1987-12-18,2002-10-17,
2008-03-20
In fact, when you really start dissecting the volatility we’ve experienced lately, technical analysis shows we are at the edge of a vertiginous cliff.
A bon entendeur salut…
back test failure…black swan..
no situation is same as before.. esp now.
back test at your own peril.
A variation of the VIX and one that I use is the decibel level of participants on business news shows. Fox, CNBC take your pick.
Geoff,
You are correct for long term investors but us invest to survive types use the spikes as short term trading opportunities.
The volatility increases show how clueless people are…first running for the exits, then trying to catch a bottom…
I have no doubt it will subdue, by consistently heading lower that is.
As long as there are guests on Fox, CNBC, etc saying “10 years from now, people will look back and say what a great opportunity this was”, one should not expect any bottom.
Further, I would bet a dollar that Cramerica will be canceled before we hit THE bottom, no two ways around it in my mind.
Is FNM, FRE nationalized yet? No? Then we are not at the bottom.
Nasdaq at 2261, and people believe we are close to bottom??!! Yeah, right.
^IXIC 1881!!
Although it is notoriously volatile I am not suggesting that anyone do it but I’d like to suggest that we take a look at the Turtle Traders rules and their results. Since most of us cannot stomach those gut wrenching and frequent reversals of fortune that are inherent in the approach I suspect that in a highly volatile period it might provide inordinate returns. Which simply might lead us to a discussion of not whether we should bet in high volatility situations but rather how should we bet.
I think APC/(V/avg V)) works better since it can show when buyers evaporate and price moves more easily to the downside, which happens less frequently than just large % moves.
Dick Arms work may be empirical and fact based, but from a cursory following of his calls over the last several years on thestreet.com, he and his ARMS indicator are one of the best contrarian indicators I have ever seen. I am amazed at just how often he is wrong.
volatility surge….
it always worked in the past so therefore it should flawlessly work in the future.
Sounds like a lot of former quants that used to be my colleagues.
How bout that bsc trade? :)
I’m a bit baffled by Dick Arm’s chart, by the look of it, when volatility starts to move up, the bottom is not in. It’s not until it’s spiking wildly, such as in 2003, that a bottom is in. Hmmm… can anyone explain?
Even if you disagree with him, you can at least respect his methodology, which has zero cheerleading content in it.
No, no I can’t. This is total nonsense. This is similar to the crap Mark Hulbert peddles. They show you some compressed time period, and even within that, they exclude periods that don’t contradict their conclusions.
These people could returns by spending their time drinking beer, watching TV and reading the Economist once a week.
This highlights why using standard linear analysis doesn’t always work (I’m a signal analysis guy by profession that is highly into nonlinear patterning). If you look at the charts from 01-03 all the volatility is sequenced. It drops big for a long time and then goes up big for a long time. Whereas the last month, it’s gone up then down then up down, etc. but not really moved anywhere.
This makes a huge difference and isn’t captured if you just look at the normal way of analyzing it. What I would do is take the distance from the 50 day MA at each point and then use that to correct the correlations (and visa versa). That would tell you a lot more than this single up/down day stuff.
BTW, does anyone know of any site where they actually have an extremely rigorous (i.e. scientific) approach to backtesting?
With all due respect to Arms and Hulbert and all of their ilk and reputation, let’s look at how they get paid. Oh? They sell info? They don’t manage money and they don’t trade and they have no audited track record of success doing either??? Nuff sed.
Follow the hints of Ross and Vermont Trader and Barry himself and learn how to read charts and honor your stops and then post some ideas and we can talk. Great posts here as usual and my thanks to all.
What is wrong with simple annualized volatility (using the standard deviation last 30,60,90 and 180 days) ? That way you can get a good grasp how volatile the markets are and if volatility is increasing or decreasing. For the future volatility (implicit) of SP500 i use CBOE VIX all the time, its simple. the current VIX value is on an annualized basis.
The Vix reached higher levels in 2002. That observation suggests that we haven’t seen the ultimate low yet. Add to that the fact that most analysts are falling all over themselves to declare a bottom. A 15% rally from here? Yes. The final low? No.
I’d have to assert that the removal of the uptick rule changes the volatility picture enough that the old formulas don’t apply anymore.
I don’t like the very short time scale. That said, we may be near a bottom… if you use a six month time scale. Both the Fed and the White House (and the banks, actually) have every reason to prop up home prices and markets and banks as much as possible if they want to get McCain elected. Particularly since that’s what they did at the trough in 2002 when they didn’t even have a presidential election coming up.
So it’s perfectly reasonable for there to be a short rally starting nowish.
A long-term multi-year rally? Hey, I could see that, if in inflation-adjusted terms the markets were flat or falling, but if that’s the case, then the correct play would be to move out of dollars.
But aside from the Fed attempting to go the Weimar route, where’s the general economic improvement that really ought to be basis for a multi-year rally?
max
[‘?’]
Speaking of reigning in onvolatility,
http://www.msnbc.msn.com/id/23853415
Bush proposes financial regulation overhaul
“The proposal would designate the Fed as the primary regulator of market stability, greatly expanding the central bank’s ability to examine not just commercial banks but all segments of the financial services industry……………
The plan would shut down the Office of Thrift Supervision, which supervises thrift institutions, and transfer its functions to the Office of the Comptroller of the Currency, which regulates banks. The plan would eliminate the distinction between banks and thrift institutions.
The role the Federal Reserve has been playing in efforts to stabilize the financial system after a credit crisis hit last August would be formalized.
The Fed would become the government’s “market stability regulator,” given sweeping powers to gather information on a wide range of institutions so that Fed Chairman Ben Bernanke and his colleagues could better detect where threats to the system might be hiding.”
Isn’t this the same OCC that under Admin direction blocked all efforts by States Attorneys General to put a lid on “Predatory Lending”, ending finally in the use of the Patriot Act and its “suspicious activity reports” or sanctioned corporate-fascist spying on civilians / commonly confused with terrorists to silence Spitzer who deserves his plight, it’s the timing that’s questionable?
http://www.bankersonline.com/security/sar/patriotcomsystem.html
“FinCEN Introduces the PATRIOT Act Communication System
Pursuant to Section 362 of the USA PATRIOT Act, FinCEN was tasked with developing a highly secure network to allow financial institutions to electronically file certain BSA forms. FinCEN met this goal by making the PATRIOT Act Communication System (PACS) available to the financial community on October 1, 2002. Initially, only the forms filed by depository institutions, the Currency Transaction Report (Form 4789 or CTR) and the Suspicious Activity Report (Form TD F 90-22.47 or SAR) will be accepted through the electronic filing process.”
Let’s put the hackers in charge of the network, now that all the data has disappeared!!!! That way only they will know where it went, imagine every one of your transactions tracked while literally billions disappear in IRAQ
May be a little taxidermy could help when going through the present volatility , it comes essentially from the financials and should one add a little more fundamental reasoning before stats betray , the conclusion is yes more volatility to come and no time to buy at this juncture.
I’m a bit baffled by Dick Arm’s chart, by the look of it, when volatility starts to move up, the bottom is not in. It’s not until it’s spiking wildly, such as in 2003, that a bottom is in. Hmmm… can anyone explain?
Posted by: Dave Patterson | Mar 29, 2008 11:55:29 AM
I would suggest that it is because at the end of a bear you have a bunch of shorts(many who are short for the first time in their trading careers) trying to get the last drops of blood out of the down move. Because shorts are notoriously skittish their exits and subsequent covering rallies tend to increase volatility and create more violent up moves
Particularly since that’s what they did at the trough in 2002 when they didn’t even have a presidential election coming up.
oh, but they did . . . the 2002-2003 intervention was specifically targeted at the 2004 economy.
You can depend on a federal FUBAR:
http://www.antiwar.com/engelhardt/?articleid=12594
Throw Arm’s chart in the garbage…it only reflects a period of two bubbles bursting and would have said buy in 2000-2001. As for stabilizing housing, it can only stabilize 40-50% lower than where it is now. I agree with the poster who said the bottom can only come after Cramer is cancelled.
I dont feel the panic. We got close once back in January -must have been around the MLK holiday, but recently it just seems like a lot of institutional margin calls, Fed PPT stock futures tweaking. The meat grinder could get turned back on as early as this week, but if this is the low its got more friends than any low I’ve ever seen and I havent missed a day in a long while.
I would have been in awe with the idea of the fed overseeing things if Greenspan or Bernanke had the forsight to take the other side of the CDO bet.
When extreme leverage is used on paper that is sub par, but rated as prime, we have seen that a black swan event is not needed in order to bring the house down. A minor head cold is sufficient to land the patient on the critical list.
Having the fed oversee things is all nice and dandy but once things get back on an even keel and the economy is chugging along nicely, will they have the constitution to put a stop to practices that are making what ever party’s donors rich or when an election is two years away?
It is like an engine where you disable the limiter. You can go very very fast but not for long.
Anyone should contemplate the CBOE VIX, we haven’t reached the levels of 1998 Russian crisis, not the levels of 2001 terror strike and not the levels of 2002 Bear Market(tm).
This is 2007 subprime aftermath, it is a major financial crisis the FED is stepping in to cover (moral hazard anyone?), approx. 2000-3000 billion dollars might be missing from the financial system. Who pays?
CBOE VIX Weekly, 1995 present date.
File: http://www.gigasize.com/get.php?d=f3wndsw4b9b
Using the APC chart provided here, it would seem that the Arms recommendation would have led to:
2000 double spike, sideways action
2001 first spike, big drop
2001 second spike, slight rise
2002 double spike, highly volatile market
2003 spike, major rise
This isn’t looking much better than chance.
Barry,
You are a big picture kind of person but I feel you are neglecting a large part of our economic picture.
When the New York Times talks about the stock market, what percentage of the total economy does it reflect?
How much capital do private corporations and businesses have as compared to public corporations?
Is the psychology of buying and selling related to the perceived success or failure of our national leadership?
Granted, the majority of the population now has a vested interest in market outcome through 401K and FDRS retirement plans but the people actually buying and selling stocks (compare block sales with the rest) aren’t even statistically significant.
I believe it is incorrect to assume that wall street is what the nation looks at to measure success. I think the inverse is true and that main street has realized that Madison avenue and wall street are con artists. Wall street traders , hedge fund managers and pension fund managers know this and are worried sick. Wall street is not in the driver’s seat anymore. The average joe on the street was the horse pulling this buggy and he’s out of work. No amount of searching for “value” stocks or “new technology” is going to change the fact that when you treat people like commodities, they will rebel. The real economy has judged the money people and is telling them to go to hell. This isn’t so much about moral hazard. There is no “benefit of the doubt” for wall street. There is a crirical mass of individuals who will not, under any circumstances, fall for the hype again. This will probably last for a generation. I can’t prove this now but if I’m right, the following events will occur:
1) A stampede to transform from public to private corporations.
2) An increase in press for altruism as opposed to “I got mine” success stories.
3) Downplaying of profit as THE thing to strive for.
4) Resurrection of Taylor’s theory of management (treating employees with respect improves productivity, good will and profit).
If I’m wrong, the fun is just begining: I.E. we hyperinflate (no more foreign debt but lots of pissed off foreigners), hypermilitate (if you can’t produce it, steal it), hypersecuritize (the return of castles and keeps) and the successful misanthrope becomes our ultimate hero (people are dying, so what?).
Our society sucks. Just because some of us have benefited from the present structure doesn’t make it right or guarantee it’s longevity. Share what you have, help your friends and maybe you can make a difference.
mikkel,
Clustered volatility is a feature of real-world markets. My knowledge of this subject is very superficial, so if I know it, it’s basic. I’ve looked at one paper simulating a market with multiple speculators using different trading rules, and the authors thought that the spontaneous occurrence of clustered volatility was a point in favor of the model.
I don’t think a voatility cluster has much predictive value for what the market will do afterwards. That’s the impression I get from eyeballing the APC chart.
I wonder how much of the volatility has been an effect of the TAF auctions – the TAF negatively impacted the Primary Dealers, many of whom are investment banks who saw liquidity shrink to fund the auctions.
Roger: Yeah that is a plus for the model. On the other hand, it is difficult to tell what the APC is.
“An elementary way to measure volatility is to calculate the daily percentage change, either positive or negative, in the price of the DJIA, using a moving average of this change to smooth the data. I used a 10-day moving average, which I called the Absolute Percentage Change indicator”
If it just took real change, and had +/- then it would detect the clusters somewhat. If it took the change regardless of sign then it wouldn’t (absolute value). It has to just ignore sign or otherwise it should have negative values and wouldn’t be so high right now.
So my point is that both that and historical volatility are affected equally by whipsawing without much movement at all (sort of like our current environment) as well as when it goes down 15%, then up 15%.
I think it is fair to say that the market tends to be mean reverting to the trend. So a high volatility and a large movement away from a moving average has a high chance of reverting, while high volatility without large movement isn’t that predictive. At least that’s my thesis. And I think volatility by its very nature does a poor job of predicting trend changes which is what the Barron’s article seems to imply.
Another interpretation might be one should not to buy until the reading has reached 1.5% 6 or 7 times over three years.
At least if you were going to buy and hold.
For traders it might be entirely different.
Barry,
You have rightly pointed out misuse of statistics on many occasions. Here seems to be a prime example of one. Looking at 6 years worth of data and data-mining on volatility? It is a little better than reading tea leaves, but not much.
mikkel,
Clustered volatility has been observed over many markets for many time periods. Whether it’s useful for predicting future price changes is problematic. And it’s usually so obvious from a chart that it doesn’t matter whether we try to quantify it with absolute differences or some kind of standard deviation measure. The SD is prettier math, but it relates to a normal distribution and the presence of clustered volatility says that a normal distribution doesn’t apply to the data. God created price and volume, but volatility is a product of presumptious man.
Do people hate stocks? Are people talking about how stocks will never go up again? Have the rallies in commodities been completely broken? Have we had some real panic selling? No, no, no, no. I’ll believe we’ve seen a bottom when we get really nasty days (DOW -500, etc) where no one steps into be a hero in the final hour of trading and unemployment moves over 100K for several months in a row. Way too many bottom-callers at this point for my taste.
The bucketing of absolute daily changes (ie, >2%, >4%, etc) isn’t as accurate as looking at realized volatility. For example, using DJIA since 1929, partitioned into non-overlapping 30D periods and check each for standard deviation. Is recent volatility is historically unusual, or was the low volatility of 05-06 unusual?
Since 8/07 30D stdev has ranged from 0.01-0.014. Over the entire series, here are the fractions of 30D periods with
stdev >0.01, <0.01, and <0.005 (several this low in 2006):
count fraction
>0.01 187 0.28
<0.01 478 0.72
<0.005 87 0.13
total 665
28% of 30d periods had similar or greater volatility than recently,
but only 13% had as low (or lower) volatility than periods in 2006.
Though current volatility is common historically,so much for the "great moderation"
O might agree w/ the time to buy and the time to sell; however, the futures market leads me to believe more forces at work to smooth the edges…I’ll pass on this old if not antiquated thought…good luck
A statistical sample of 4-5 events is mostly useless. Most analysis of volatility shows zero correlation with entry and exit points or related strategies. Vol is usually autocorrelated and mean reverting but not much help otherwise. Where are the multi-market, long term studies?