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The Relativity Of Volatility & 100 Year Floods at Trader’s Narrative





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Here’s an interesting article from Barron’s Online today: The Best Way to Use the VIX

Bill Luby, editor of the blog, VIX and More, said, “A classic misuse of the VIX is as a market timing signal. The VIX is generally negatively correlated with the broad market indices, but this correlation waxes and wanes.”

This throws conventional wisdom a curveball right away.

He continued, “Further, investors tend to believe that absolute numbers for the VIX are sacrosanct, so that a VIX of 30 or 50 or 70 starts to take on a special significance [see Chart 1]. For the most part, my research and experience suggests that absolute VIX levels are much less meaningful than the current level of the VIX in relation to recent levels.”

This is something I’ve outlined more than a few times:

Although looking at volatility through the prism of relative performance helps us to understand it better, it can still at times be elusive. This chapter of market history is just one of those times. What we have seen recently is such an outlier that even when we look at relative volatility, rather than absolute volatility, we still see an aberration worthy of extreme value theory. With one exception.

I looked at the CBOE NASDAQ volatility index (VXN) and compared it to its simple 150 day moving average. Here is where we are now relative to where we’ve been before:

nasdaq volatility index VXN relative to 150 day moving average

In 1998, the distance of the VXN from its 150 day moving average peaked on early October, just as the market made the final low. In 2000, it peaked in mid April but the market was far from a lasting low. And that brings us to 2008 when the relative VXN peaked in late October.

My hunch is that during “normal” markets, the VIX and VXN provide great signals. But removed from a stair stepping bull market, things can easily become extreme and lose meaning. What we saw in early 2000 was the pricking of an asset bubble and its consequences. What we are seeing this year is the pricking of a credit bubble and its consequences. Until we once again see “normal” markets, the volatility gauges will be an interesting sideshow.

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One Response to “The Relativity Of Volatility & 100 Year Floods”  

  1. 1 Fernando

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    I was shorting the market the whole year till November. After that I been going long on the market since 7400! I said that was my level and that i was going to buy there! But the question is where to?

    I personally believe this is a bear rally! And as a bear rally i don’t want to fall in love with my longs play!

    I see that there will be some resistance at the 9500s level…but I’m not sure if market will stop there. It could come down from there and then go back up (this my believe). But you can bet that i will do some shorting around that level to test the market!

    Fundamentally i want the market at 11000s. If it gets there it would be the best shorting extravaganza ever! After it gets to 11000 market could collapse again but this time lower!
    Like i said in the past we will have to deal with inflation. And that’s not going to hit us till later. So a possibility of hitting us at 11000 is more likely now.

    And last, I did not believe that market can come to 4000 as many people have thought, but giving the right conditions, it could easily come down there after this nice bounce!
    (Mind me saying that if it breaks the 7000 level the next support is 4000! So there is a chance it can come down there. And when it comes down there, it would be depression levels)!

    Any thoughts guy would be awesome! I like to hear opinions :p

    Fernando

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