Thursday, April 8, 2010


Volatility in both the stock and bond markets has declined since 2008. This is “normal” and expected given that volatility tends to be mean reverting and cyclical. The overall decline in volatility has also led to investor complacency in both markets. This can best be seen by the lower levels of the VIX index in stocks and lower levels in the MOVE index for bonds (the attached charts are from Yahoo and The Macro

The main question, for traders and investors, is have we now entered a period where volatility stays lower for an extended period of time, such as 2004-2006, or are both markets sending a signal that the probability of something “big” occurring has increased. A very thought provoking analysis of the MOVE index, done by The Macro, states that significant economic events occur more frequently than expected, which is classic Mandelbrot analysis (see some of my earlier posts), and that the MOVE index is at levels where historically significant events have occurred in the past, such as the LTCM debacle, the .COM tech crash, and others.

As intraday traders we look at the market from shorter term time perspectives, nonetheless, this does not mean we should ignore longer-term time frame analysis. The bigger picture analysis seems to suggest that we are entering, or have entered, a period where either: 1.) things are just “calming” down from a unique, crazy, and tumultuous economic period, and its business as usual, or 2.) this is the calm before the storm, there is a higher probability of a shock on the horizon, and being defensive and cautious is preferable. What do you think?

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