Is the Market in for Some Massive Volatility?
A recent Wall Street Journal report reveals major correlation in price movements of various assets, indicating potential market upheavals and volatility.
The market could be in for some violent swings since there has been major correlation in the price movement for the various risky assets in January. So there could be major market upheavals, says experienced analyst Mark Kolakowsky in this Investopedia article. Wall Street Journal reports that in 9 out of 12 trading sessions held recently, the 10-Year US Treasury Note yield, the US crude oil price, and the S&P 500 Index all moved in tandem. In nearly a year this was the greatest level of correlation displayed by these assets, reported an article on The Wall Street Journal. And it is considered an indication of heavy volatility ahead.
Volatility is usually associated with massive swings in the positive or negative direction. If the market rises and falls over 1% in a period of time, it is considered volatile. This volatility is measured by the Volatility Index (VIX). The purpose of the VIX is to measure the 30-day expected volatility of the market, and is derived from the call and put options of the S&P 500’s real-time quote prices. It shows the future bets made by traders and investors on the path of individual securities or markets. If the VIX shows a high reading, it indicates the market is volatile and therefore risky.
When depicted as the percentage coefficient in the option-pricing formulas, volatility is caused by daily trading activities. The method in which volatility is measured affects the coefficient value used. Volatility is the level of risk or uncertainty that is related to the changes in value of a security. Higher volatility indicates the ability of a value to get spread over a wide range of values. The security price could dramatically change in any direction in a short period of time. If the volatility is lower, the security’s value remains steadier and does not undergo a dramatic fluctuation.
Market Turning Points Could Be in the Horizon
But the above-mentioned Wall Street Journal report does note that high correlation periods have historically preceded major market turning points. And these turning points are where volatility is all too evident. This current period of high correlation could end up in some possible scenarios, according to the Wall Street Journal:
- As we mentioned before, investors could be making bets that are similar on a variety of asset classes.
- Bets could ignore fundamentals and follow broader themes such as global growth.
- The breakdown in correlations could result in positions potential going through a rapid unwinding
- There may be more orders to buy or sell stocks as a result of computerized trading models
- This flood of orders could result in massive price movements up or down
As a trader, what can you expect from this? The advantage of trading with a long-term focus is evident here. Sudden reversals in the market usually affect traders having short investment horizons. But this situation also creates opportunities. So, investors having long range focus tend to benefit from these opportunities. Trading for short term or long term requires a great platform and a great broker with low commissions or fees.
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