Many times, when markets experience extremely high volatility they then proceed to trade sideways as volatility reverts to its mean. This is exactly the opposite behavior that occurs to when low volatility reverts to its mean.
Let me show you a couple of examples. In Figure 1, on April 21, 1999, CMGI’s six-day volatility reading reached 209 (a), which was well above itâ€™s 100-day reading of 150 (b). As you can see, after volatility peaked and began reverting to its mean, stock prices proceeded to sideways for the next three weeks (c).
|Figure 1. CMGI, daily. Source: Omega Research.
In Figure 2, on April 20, 1999, NDB’s six-day historical volatility reading reached 425 (a), which was well above the 100-day reading of 232 (b). Once again, after the volatility peaked and began reverting to its mean, stock prices proceeded to trade sideways for the next four weeks (c).
|Figure 2. NDB, daily. Source: Omega Research.
It’s certainly more exciting to find low-volatility situations that are about to explode, but itâ€™s also good to know when stocks have a higher-than-normal likelihood of moving sideways over the next few weeks.