Will we ever break out of this range?
I field a handful of emails each day, addressing topics ranging from data
analysis to psycho-analysis. Far and away the most common recent topic
among writers, however, is the current trading range and its significance.
It seems as though quite a few writers expect a major breakout in early
2006. A common refrain is that consolidation ranges lead to breakouts and
major trending movements. Most of my correspondents seem to favor the
upside on any such breakout.
Not wanting to rely solely upon speculative opinion or trading lore, I
decided to go back in time and examine trading ranges such as we’ve had
recently. My analysis went back to January, 1990 (N = 4014 trading days)
and examined 20-day periods of price change and volatility (trading range) in
the S&P 500 cash index. Here is what I found:
1) We truly are seeing historic levels of low volatility. The
price range for the past 20 days has been about 2.1%. This places the most
recent 20-day period in the lowest 1% of all volatility periods for the sample
overall. With the exception of a single period in August, 2005, we have to
go back to 1993-1995 to find comparable levels of low volatility.
2) I compared the quarter of 20-day data periods with the lowest
volatility (average range = 3.27%; N = 1003) with the periods that possessed the
highest volatility (average range = 10.88; N = 1003). Twenty days after
the low volatility periods, the S&P 500 averaged a gain of .49% (603 up, 400
down). Twenty days after the high volatility periods, the S&P 500
averaged a gain of .96% (588 up; 415 down). Low volatility periods were
just as likely to result in upside movements as high volatility periods, but the
upside was greater after those high volatility periods.
3) I compared next 20-day volatility following the quarter of occasions
that were highest and lowest in volatility. The average twenty-day price
range following the high volatility periods was 8.88%. The average
twenty-day price range following the low volatility periods was 4.46%. In
other words, on average, low volatility periods did not resolve into breakout,
volatile movements. Low volatility, on average, tended to beget further
low volatility and vice versa.
4) I looked at low volatility periods that also displayed small price
change, as we have seen recently. This provided a sample of 173 occasions
where 20-day price change was neither up nor down more than .40% and where the
price range was in the lowest quartile for the sample overall. Twenty days
later, the S&P 500 was up on average by .60% (111 up, 62 down), compared
with an average gain of .74% (2433 up, 1581 down) for the sample overall.
Interestingly, the average price range 20 days following the low price
change/low volatility periods was 4.43%, below the 6.35% average for the overall
sample. Low volatility again led to low volatility.
What can we conclude? This certainly is a period of low volatility and
low price change. Such times have occurred over the 16-year period
studied, but have not resulted in a distinctive directional edge 20 days
later. There is a bullish drift embedded within the 1990-2005 sample, and
we see the same drift following low volatility periods as at other times.
That doesn’t mean that we cannot decline over the next twenty days–indeed, my
website has detailed some of my intermediate-term concerns regarding
weakness in the broad market–but it does mean that there is no general,
historical bearish edge when price change and volatility are low.
What we do see is that low volatility does not generally beget high
volatility. The twenty days following a low 20-day volatility period are
more likely to have a narrow trading range than a broad one. Putting all
of one’s chips on a breakout move of large proportions may pay off, but the
historical odds do not support that wager.
Brett N. Steenbarger, Ph.D. is Associate Clinical
Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical
University in Syracuse, NY and author of The
Psychology of Trading (Wiley, 2003). As Director of Trader Development
for Kingstree Trading, LLC in Chicago, he has mentored numerous professional
traders and coordinated a training program for traders. An active trader of the
stock indexes, Brett utilizes statistically-based pattern recognition for
intraday trading. Brett does not offer commercial services to traders, but
maintains an archive of articles and a trading blog at www.brettsteenbarger.com
and a blog of market analytics at www.traderfeed.blogspot.com.
He is currently writing a book on the topics of trader development and the
enhancement of trader performance.