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Volatility over trend and price is here to stay

By Daryl Guppy (China Daily)

14:53, March 19, 2012

The Dow Jones Industrial Average has enjoyed a rising run of more than a week. It's a long winning streak and it has led to a burst of optimism about the strength of the United States economy. All this despite Citibank and four other major banks failing the latest round of stress tests.

However, a feature of bullish markets is that bad news is ignored and good news, no matter how small, is trumpeted and feeds the continuation of the rally. This has helped to strengthen the US dollar and drive a collapse of gold prices to the lower edge of the long term upward trading channel.

It has also led to a new five-year low reading in the VIX indicator. The VIX is the ticker symbol for the Chicago Board Options Exchange Market Volatility Index and it is a popular measure of the implied volatility of S&P 500 index options. It is sometimes called the fear index. The VIX is quoted in percentage points and shows the expected movement in the S&P 500 index over the next 30-day period, which is then annualized. High VIX readings occur when investors anticipate an increased probability of large moves - up or down. It is used as a measure of options volatility but volatility in the market takes several forms. A low VIX reading does not mean volatility has left the markets.

Volatility comes in several different flavors. There is price volatility and trend volatility. There is little evidence that price volatility has reduced and there is no strong evidence that trend volatility has diminished. This has important consequences for investors. It may not yet be safe to go back into the water.

Price volatility is measured by the difference between the range of average price moves and the extreme ranges of price movements. It is also a function of the frequency of these larger price movements. Chart A shows a blue-chip stock with a high level of price volatility within an established upward trend. Price movements of 6 percent to 9 percent are common. These lunges in market price occur without warning. Some of these volatility moves plunge the price below the trend line but then close above the trend line. The general direction of the trend is stable, but the behavior of price within the trend is unstable.

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