Are Markets Becoming More Volatile? One Highly Sensitive Indicator Says Yes
The ATR metric increased 85% since "QE tapering" comments, representing a volatility increase that should not be ignored.
– Frank A. Dusch
Ever not notice something until someone points it out, and once they do, that’s all you see? Or even better, you know the feeling of getting a new car, thinking how special yours is going to be, then once you buy it, you see the same car everywhere? It is amazing what cognitive perception can have influence over. The same goes for market analysis. And yet, with so much an investor can follow, how does he or she keep track of it all?
My firm is what's called a "fusion analysis" firm. Simply put, fusion is the unification of several analysis disciplines rolled into one. We combine fundamental, technical, behavioral, and quantitative together in order to ascertain the greatest probable outcome. Sometimes this can lead to a 'nil' result, or better put, an inconclusive one. When this occurs, it indicates a potential consolidation period is lurking. This is where our analysis has led us since the 5/22/13 infamous "potential tapering" comments by Fed Chairman Ben Bernanke.
Of late, one technical fusion metric has stood out and influenced our analysis outcome on confidence in short-term direction: the Average True Range (ATR). The ATR metric is simply a measure of daily volatility. It provides a 14-day average of the daily percent range of the market. For example, if the S&P 500 (INDEXSP:.INX) was at 1,600 and the 14D-ATR was 1%, the expectation would be that the market would range 16 points from the intra-day low and intra-day high. (Note: ATR can be a more sensitive volatility metric than the characteristic standard deviation, which I will not venture into in today’s article.)
Click to enlarge
Over the past three weeks there has been a shift in volatility, which may have gone unnoticed -- until someone points it out. The 14D-ATR has increased 85% since the "tapering" comments; a 0.7%-per-day to a 1.3%-per-day volatility increase should not be ignored. Typically, an increase in volatility indicates a shift in tone -- buyers and sellers intensifying their opinions, if you will. What is also noticeable is how the volatility metric, on this latest move, has surpassed a downward trend held for the last year (red arrow line in chart). By itself, this may not be critically significant. Yet, when adding it to a myriad of other factors, it becomes a staple in the weight of evidence used in determining risk.
Typically, I attempt to focus on one risk topic per article, but considering the aforementioned statement, a small tenet disruption is necessary. The SPX/ATR chart above also illustrates the MACD. This secondary momentum indicator has, for the first time since the November “correction,” crossed negative, and adds to my firm's "inconclusive" (nil) stance on market risk. The last and final telltale sign when shifting risk stance, the straw that may break the camel’s back, will be a break of the price trend since the November correction lows (blue arrow line on chart). This would deepen our conviction of a “short-term” (two- to four-month) correction.
I hope this helps and finds you well.
Editor's Note: Read more at Tesseract Asset Management.
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