Current market volatility and staying the course

In the last couple of weeks we have seen an ever-increasing level of volatility within the context of a sharp drop in price in the major market averages.

We have also started to see intervention in the markets by governments and regulators - additional liquidity being provided and interest rate cuts, as well as market trading halts (up and down) being triggered and the introduction of short selling bans on certain stocks.

You think the markets are volatile? Think again...

I've mentioned a few times this year, both here and on social media, that the current levels of volatility may seem quite high (certainly compared to the more 'normal' recent levels), but these are nowhere near the levels seen in 2008.

To show what I am talking about, at the bottom of this post I've shown the monthly chart of the Dow going back to the early 1970's. And then, I created a simple measurement to show the change in volatility, by taking the typical 2ATR measurement calculation and expressing this as a percentage of current price.

Trading the line of least resistance

A lot of the people who were profitable in 2008 became unstuck the following year. They seemed to get in their head that, once the markets started rallying, they were anticipating a further, more pronounced price drop.

In the summer of 2009, they got their chance. There were numerous trading blogs of the day talking about a 'head and shoulders' pattern which had formed on the indices between May and June, and they were going to use this as a trigger to go short the market, and really make a killing.

Risk and the 1987 stock market crash

This coming week marks the 30th anniversary of the 1987 stock market crash. On 'Black Monday', the world's equity markets were in chaos.

Following this, circuit breakers were introduced in an attempt to prevent such dramatic one-day moves. These were further strengthened following the May 2010 'Flash Crash'.

Some thoughts on volatility

Below is a chart of the Dow where I have zoomed out to show a longer-term view going back more than a decade. This shows that the current levels of volatility (as expressed by the 2ATR measurement) have only been reached three times in the last 8 years:

• August 2015 - when there was a short, sharp movement downwards which got quickly repelled;
• August 2011 - ditto
• 2008 through to early 2009 - when we were in the throes of the financial crisis and the big market downtrend.

Food for thought

For those pronouncing that the bear market is over, the bottom has been reached, etc etc...a possible red flag for you to consider.

Watch for the warning signs

If you have been long stocks, the last couple of weeks would have been brutal. The bears have definitely held the upper hand, and it seems (nearly) everyone accepts we are now in a bear market. 

Of course, alert traders would have been aware of this for a while now - banking stocks for example topped out early last summer, before 'Credit Crunch' became the phrase used in every news bulletin.