Market Volatility

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enigma
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Market Volatility

Post by enigma »

Market volatility, percentagewise, has remained more or less the same. According to Stridsman's analysis, the have in fact decreased somewhat. Question is, why must the dollar-value of market indices fluctuate more with the market level so that the percentage volatility remains the same?

Is seems quite strange (to me anyway) that there's seems to be some sort of mechanism which makes us trade more actively as the index level rises (I'm assuming that more volatility dollar-value-wise means more trading, since that is required to move prices). Is it because there's more money going around, more players, or has human behaviour indeed become more volatile? Probably a bit of everything.
edward kim
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Post by edward kim »

Simple mathematics can explain that fairly well:

If the S&P is at 400 and you have 10% volatility, the S&P must fluctuate 40 points.

If the S&P is at 900 and you have 10% volatility, the S&P must fluctuate 90 points.

Same volatility, more dollars because the index level is higher.

Edward
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Post by Kiwi »

mmmm ... but our friend does have a valid enigma. :)

To move the market 10% at 900 pts you have to move it 90pts which for a fixed number of shares outstanding in the underlying stocks should imply 2x the money flow required at 450pts.

I'm not sure why this relationship holds --- does anyone feel that I'm not thinking right here? One thought I have is that if no one wants to sell then very little buying is needed to push price higher but I dont think that this would apply on average over a number of years.

I just had a look at SPX from 1980 to 2002 and have to say that Stridsman's assertion that volatility has not changed doesnt seem to be valid. Using ATR(90) / Mov(C,90) as a normalised measure of volatility I note that from late 1998 the percentage volatility of the index has been nearly twice what it was in the early 1990s. That may well represent the final froth of the bull market and the more volatile effects of a bear.
enigma
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Post by enigma »

Kiwi,

You've got my point exactly :D

eck,

That's the thing that seems strange to me ... why the standard deviation should stay approximately the same. It's almost as if everyone agreed to move the market more (in absolute terms) today than they did 10 years ago.
edward kim
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Post by edward kim »

Hi Enigma,

There are two separate issues that you are inquiring about.

The level of the index does NOT imply the level of volatility. 10% volatility is 10% volatility, no matter what the level is. The markets can fluctuate 10% if the Dow is at 10,000, just as it can when it was at 1,000.

The second issue you are asking about is WHY it seems like volatility increases as indexes rise. Like John mentioned, maybe it's a rash of participants late in a bull stage that creates wild swings, while bear markets tend to wash out the weak hands (the public in general is long-biased.)

There is another issue in that the way indexes are calculated can affect the volatility calculation. The S&P is a market capitalization-weighted index, while the Dow is a price-weighted index with a divisor that gets readjusted for stock splits.

To make an easy example, suppose all 30 Dow stocks are $50.00 each and the divisor is set at 0.5. If all stocks moved up $1.00 in price in one day, you would have:

(30 X 1.00) / 0.5 = 60 Dow points

Now suppose all 30 Dow stocks rallied to $100.00 per share, they all did 2-for-1 stock splits, they are now all $50.00 each again .. the divisor would be cut in half, and is now set at 0.25. If all stocks moved up $1.00 in price in one day, you would have:

(30 X 1.00) / 0.25 = 120 Dow points

The Dow is twice as high as before (because all stocks went from 50 to 100), so the Dow would have twice the point movement. However, RELATIVE to each stock's price movement, the Dow is moving twice as much for each $1.00 increase in the stock. Stocks are moving 2% ($1/$50) in both cases, but the effect on the index is different.

There should be a distinction in the way volatility is assessed relative to indexes and individual stocks/futures.

Edward
si
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Post by si »

eck wrote:The level of the index does NOT imply the level of volatility. 10% volatility is 10% volatility, no matter what the level is. The markets can fluctuate 10% if the Dow is at 10,000, just as it can when it was at 1,000.
I think Enigma's question is : To have the same level of fluctuation, a one tick move when Dow is 1000, corresponds to a 10 tick movement when Dow is 10000. Why aren't people still trading in the same absolute amounts as they were earlier? If they would do that, the Dow should only be 1% volatile.
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Post by leonardo »

I think Enigma's question is : To have the same level of fluctuation, a one tick move when Dow is 1000, corresponds to a 10 tick movement when Dow is 10000. Why aren't people still trading in the same absolute amounts as they were earlier?
(This is not meant as a flippant answer)

Because markets are risk transfer agents. When there is greater apparent market risk--fear or greed-- volatility increases.

If values are greater, then the risks and necessary rewards for capital invested are greater.

Money once created gravitates to its most efficient use.

Leonardo-----
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Post by si »

leonardo wrote: (This is not meant as a flippant answer)
Leonardo, Do not worry. I am not easily flipped out. :wink:

To the original poster, I would say: ask yourself whether you are trading in order to learn more about market fundamentals -- the "why" questions. That road does not lead to a pretty place.

--si.
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