When Low Volatility Doesn’t Mean A Market Will Move
Today’s volatility column is brief and will help you identify the few times when low-volatility situations do not lead to large moves.
As you are aware, large market moves are often preceded by exceptionally low shorter-term volatility readings relative to longer-term volatility readings. Occasionally, though, an out-of-the-ordinary event will cause the volatility of the market to go out of whack.
For example, if a company announces earnings that are well below expectations, its stock price will likely collapse. If a stock drops from 70 to 30 overnight, its volatility will soar. This massive move will then be reflected in the various volatility calculations. Therefore, if the move happened 10 trading days ago, a 6-day high volatility reading will not reflect the move (because it happened 10 days ago) but a 100-day high volatility reading will. The 100-day reading will be higher than it should be due to this abnormal event, and as a result, shorter-term high volatility readings will–by comparison–appear much lower, and will trigger more readings under 50%.
In summary, when a short-term volatility reading is less than one-half a longer-term reading, it is likely signaling a large move as volatility reverts to its mean. Just make sure the longer-term period is not reflecting some abnormal event that is making its reading above average.
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