Complacency in the Volatility Market

I was away from the office for a few days but upon returning it’s nice to see that trades have pushed equities higher as some of the major indices approach their prior highs. However, this has caused volatility to get back under 14 and the level of compression within the $VIX has hit such a level that causes me to give pause.

Volatility of volatility (as measured by VVIX) has fallen back to a level that for the last year and half has marked several low points for the $VIX.

VVIX

This, along with several other indicators that I closely monitor, has me watching volatility right now. While we head into a long holiday weekend, Jason Goepfert of SentimenTrader notes that since 2010 seasonality after Memorial Day hasn’t been extremely bullish for stocks, “Since 2010, the week of the holiday (next week) was positive only once (+1.2% in 2014). The other five years averaged a loss of 1.9%. None of the six years saw the S&P rally any more than 1.5% at its best point during the week.” Not that markets must follow their past playbook, but this negative slant of seasonality paired with what I’m seeing in volatility markets could play out in the bears favor in the coming weeks with a pop in the $VIX. We’ll see what happens.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Expecting A Bounce In Volatility

The S&P 500 has rallied over 10% since the February low, push the index up to its 50-week Moving Average. Meanwhile the Volatility Index ($VIX) has declined approx. 47%, sending the ‘fear index’ to its lowest level so far this year.

One way to use Moving Averages besides in terms of trend identification and areas of support and resistance is measuring how far a security or market is from its specified average price. Currently the $VIX is the furthest it’s been from its 50-day MA since the prior lower high in the S&P 500 back in October 2015. As the chart below shows, it’s now more than one standard deviation below the mean based on the distance Volatility historically travels away from its 50-day.

Previous instances of the VIX falling this quickly has led to tough market conditions in the short-term for equities. As I mentioned on Twitter yesterday, the $VIX is also near its 200-week Moving Average, which has been an important level in the past. Steve Deppe also shared on Twitter that when the VIX that since 1990 when the index’s 20-day return is less than -30%, the average forward return for the S&P 500 over the next 5, 10, 20, and 40 days has been negative.

It’s important to remember that there are two ways that Volatility can correct it’s current stretched condition – time and price. We could see VIX move sideways and remain near 15, allowing its 50-day MA to ‘catch up’ or we could see a bounce sending Volatility higher. We obviously can’t know which option will occur, but it does seem that some form of mean-reversion needs to occur – whether it be via time or a large price movement.

sp500-vs-vix-50d-rsma-params-5y-red-x-x

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Are We About to See An Increase in Volatility?

One of the many tools in technical analysis are Bollinger Bands, which measure a set standard deviation price has traveled from a defined Simple Moving Average, in a way it’s measuring the volatility of a price move. Many traders often use Bollinger Bands as levels of potential support and/or resistance. However, I’m much more concerned with the distance between the bands themselves. Which, when applied to the Volatility Index, is showing signs of a potential rise in the $VIX.

When the upper and lower Bollinger Bands compress, it’s a result of a lack of change as measured by standard deviation, in this case, over the last 20 trading days. History has shown us that when this compression in the width of the Bollinger Bands for Volatility gets low enough, it has preceded spikes. Below is a chart of the $VIX over the last three years, with the width of the Bollinger Bands shown in the top panel. I’ve put blue dots on the VIX when the width has fallen below 20. While the $VIX hasn’t spiked immediately following every instance of this occurring, many large moves in volatility have followed such a compression in the Bands.

VIX

To shine a little more light on this topic, below is a list of times we’ve seen the bands width fall below 20 for the first time in two weeks and the $VIX itself was below 25. While the percentage of the time volatility was higher the next 1, 2, 3, 5, 10, 15, and 20 days ranges from 43% to 65%, what stands out to me is the minimum and maximum changes. Typically the minimum move over the shown periods of time is less than 10%, the maximum advances in volatility have been quite large – the mid-double digits.

Even though the number of instances the $VIX has risen has been low (typically less than 50% depending on the time period), when it does go higher we have seen some very strong moves to the upside in volatility. With the width of the bands now sitting under 20, it’s possible we see volatility pick up over the coming two weeks, if not sooner.

Understanding the probabilities and potential outcomes of historical market data is an important tool to being a successful trader.

VIX compression table

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.