Thoughts on volatility

Markets are nothing if not volatile at the moment as last nights price action again showed. From the low yesterday after the employment number the AUD has rallied 230 pips to sit at 1.0336 as I write. The Dow finished up 423 points or 3.95% and equities and so-called risk assets generally had a much better night.

But the question is what are these market moves telling us – is it a top of a bottom?  This type of volatility is not usual in markets, even though the price of volatility was higher back in the early days of this financial crisis (see chart below) in these dark days of the late 2008 early 2009 panic in the markets we didn’t see the size and scale of these moves in opposing directions we are seeing this week.

It tells me a couple of things – first the short-term and high frequency traders are in charge of the market at the moment which is not a good sign at all for health of markets or the global economy. These guys are the velociraptors of finance rooming around the jungle scaring and eating anything in their path.

The second thing that this volatility tells me is that no-one really knows and people are scared. Scared of putting on trades and getting stopped out, scared of what it might mean for the superannuation in Australia or 401k in the United States and generally just worried about the outlook.

But for those of us who spend our time study the structure of markets in order to try to discern some clarity as to their direction this is a really interesting week. Moves like the ones we are seeing at the moment, coming after a very deep move lower in the past month could be a sign that the market is trying to put in place a bottom. I am using the S&P 500 as the bellwether index for global equities and the bellwether of risk – for example over the last month the correlation between the movements in the AUD and Australian 3 year swap rates on a daily basis with the moves in the S&P (directionally) has been 0.848 and 0.829 respectively. Over three months these correlations have been a still strong 0.773 and 0.77 respectively.

At its lowest point this week the S&P had fallen 18.17% from where it was on the 22nd of July when all this carnage started – that is a very sharp move lower and structurally markets are very oversold. I have put an orange box around the last week’s trade and the lower part of the graph is the MACD indicator I use for helping me tell when a market is oversold or overbought. Now interpreting these things is more art than science but this indicator suggests the market is heavily oversold at the moment.

In general we would be looking for a bounce, or a period of stability in prices to wash away this oversold position – from a purely technical perspective that would be the way that I am betting (not advice though folks this is just my view). this should wash through other markets as well which are following the moves in US equities.

The question of sustainability is another question entirely and one that rests on economic outcomes over the coming months and the ability, crucially, of central bankers and governments to get their arms around the European debt problems that remain front and centre of investors and traders minds. For mine I am hopeful that the market can stabilise because even though I have a view that the global economy is weakening fractured equity markets will just exacerbate the downturn as they sap the life of people’s confidence in their economic future.

The one thing we do know though is that while the short-term traders are in control volatility reigns. Traders can and are trading this volatility but for longer term investors the sidelines or current positions is the place to be.

This blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

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  1. > These guys are the velociraptors of finance rooming around the jungle scaring and eating anything in their path.

    Couldn’t have chosen a better metaphor! 🙂

  2. “the short-term and high frequency traders are in charge of the market at the moment

    “at the moment” is redundant. They are and will remain in charge.

    • GG, DFM is implying (and rightly) that during very high levels of volatility (which are caused by HFT), only they are moving the markets around.

      In the medium and long term, its position traders and institutions that move the market, but it should be said we all react to each other.

  3. “The one thing we do know though is that while the short-term traders are in control volatility reigns. Traders can and are trading this volatility”

    Indeed, ka-ching, ka-ching 😉

    These moves are so wide even short term longs have been opened in the 150pip area against Yen and even larger against Euro. I’ve even taken a short on Gold off 1805 down to 1740.

    On the MACD, I gave up on that eons ago. Try RSI(7), MFI(14) and Williams%R(14).

    “These guys are the velociraptors of finance rooming around the jungle scaring and eating anything in their path.” Really? Thats a bit harsh, we are just taking the opportunities that are presented. Some of us are rather pleasant and altruistic fellows.

    “first the short-term and high frequency traders are in charge of the market at the moment which is not a good sign at all for health of markets or the global economy.” NO! Central bankers are with their ridiculous FX interventions and PPT antics. If they just f***ed right off you’d have a sharp bear market and it will be over and calm ala sea after a storm.

    • Deus Forex Machina

      Hi Rota

      I’ll have a look at your indicators – I find the MACD only works for me if I have the histogram, otherwise its useless to me for some reason. that’s the art part I guess

      On the ST trading, I should have been clearer, apologies. I don’t mean short term traders like you and many of my friends and colleagues (and me on occasion)I mean the super high frequency robots running algo’s prowling around and pushing from one side to the other.

      Nothing wrong with short term “human” trading as you know that’s where a lot of liquidity comes from but I reckon the robots don’t help market efficiency at all – they just clip coupons and muk things up…

      you may still disagree but thanks for letting me clarify

      And I do have some sympathy for a short sharp clean out of the economy so far we’ve protected the protected while the rest of the economy sits back and gets screwed with austerity and no jobs

      • No probs, thanks for clarifying, I misunderstood your intent ref us that swing trade ranges. You are totally correct on the Algo’s and HFTs.

        You are dead right on the MACD histogram being excellent for directional change but the interesecting signals are all over the shop IMO and rarely correlate (maybe my settings need work) and when they do its sadly lagging.

        Other than the misinterpreted crack at swing traders it was good piece of analysis. 🙂

        BTW AUDJPY is forming a triangle and the swings are contracting…your breakout is coming.

  4. Thanks DFM that’s a really useful insight to the trader’s mindset.

    I wonder also if the volatility reflects the overwhelming sense that the current level of central bank sponsored balance sheet protection means the capital markets have ventured off the map and markets are wondering if the old rules still apply?

    • Deus Forex Machina

      There is something in this…if the Central Bankers and Governments were doing a better job then there would be less uncertainty which would mean that there would be more people participating in the markets which would make it deeper and potentially less volatile.

      Policy makers, as Rota states above are (and have) making this whole mess worse…they keep trying to buy time – which I get – but they just keep making people nervous.

      So people don’t play and markets become thinner meaning that the HFT algo’s can push the market from side to side or up and down with little opposition.

      I think the old rules for markets and how to trade them still apply and you certainly have to factor the HFT guys into your equation but its the lack of leadership, or in some ways cluelessness, of the economic and political ruling class that is really worrying people.

      IMHO anyway

      • Every few days between 3pm and 5pm Eastern I await the Bank of Japans YEN dump…and every market reacts and cue chaos for a while…and then there is the Swiss National Bank at night *sigh*.

        If you don’t have tightening stops and hard R and S targets you are screwed.

  5. Deus Forex Machina

    For anyone interested here is a couple of pieces on HFT guys for background.

    And here is a piece I wrote a long time ago on this very topic –

    The link to Andrew Haldanes speech at the bottom is worth the effort.

  6. This was makes the calls from lefties for more Government control of markets so annoying…it is the Government and their haphazard and unpredicable interventions that are causing the volatility.

    When BErnanke can sway the market so much with a few paragraphs – it should be obvious that the cause of the volatility is Government meddling.

    If it was a pure market – then the information available to everyone would be what moves the market and the direction would most likely be down down down!

    • Deus Forex Machina

      Stavros the HFT guys are not part of the “normal” market where we can all trade on the information at hand.

      They exploit a technological advantage to to buy and sell in nano-seconds.

      This is not about regulating the markets per se it is about ensuring a level playing field for everyone.

      I am certainly not for regulating everything but somethings just add no value to the market clearing or facilitation role.

      It’s not a pure market when its rigged in favour of a machine.

      As I noted above I have great sympathy for the idea that the CB’s and Pollies are making this worse.