Yesterday we wrote our tongue in cheek “VIX. RIP.” post, not so much to point out that volatility is getting uber-low, but as a reminder of just how many times we’ve heard that volatility is inevitably going to spike.
In a morning note from Waverly Advisors, we get some more perspective on volatility and a reminder that no, there’s no reason to think volatility will shoot up anytime soon.
We present the chart above mostly for perspective—seeing the last 10 decade highlights the
extreme volatility of the Dot.Com bust and the more recent Financial Crisis, but we can also
see clearly that there have been extended periods of much lower volatility in between. In
general, there are several important facts about volatility to keep in mind:
Volatility is somewhat more predictable than price. We believe that one reason for
this is that while buying and selling pressure can easily correct imbalances in price (eg.
Buyers step in to support at what they perceive to be reasonable prices), there exists
no mechanism to dampen patterns in volatility.
Volatility has two characteristics that make it possible to design high probability
trading strategies: It is trending in the short-term and mean-reverting in the long
term. Many writers believe that low volatility environments give rise to volatility
explosions, but we have not found support for this claim in the (extremely large
amount of) data we have examined. Rather, we believe this pattern is simply a
function of mean reversion in volatility.
Volatility is highly correlated with trading volume and is inversely correlated with
price. Though the mainstream media likes to talk about the VIX every chance they
get, 80% of the time they are simply reporting that the market moved in the opposite
direction! That the VIX went up when stocks went down should surprise no one.
With respect to price, there is no predictive power to volatility. It is far too common
to listen to market commentary suggesting that, for instance, a very high VIX reading
means that stocks are going down. A very high VIX reading almost always means
that stocks have gone down in the recent past.
There are far better measures of volatility than VIX. The media focuses on the VIX
because it is facile and popular, not because it is the best way to understand volatility.
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