Volatility is running high, but that’s probably a good thing

Volatility has been at the top of many trader's minds of late. It's hard to miss the references to the VIX on CNBC and elsewhere in the media. I heard someone suggest that volatility is an asset class of its own now. Volatility is derivative, of course, so that can't actually be the case, but it does speak to the fixation there is in the market at this point.

The amount of chatter, though, makes me wonder if people have forgotten what things were like in 2008. I mean look at where the VIX is now compared to where it was three years ago. It's not even close. Heck, it didn't even get above the peak from 2010 at its highest levels during Q3.

 

Of course the VIX, which is a measure of the implied volatility of index options, is only one way to look at volatility. We can also look at price-specific volatility.

The DAX has been at the heart of the risk on/off ups and downs of the global markets through this whole sovereign debt crisis, so it's worth taking a look at that index. The chart below shows the weekly performance going back to late 2008.

Turn your attention to the two sub-plots.

The top (blue) one measures the width of the Bollinger Bands relative to the 20-week average. This is the Band Width Indicator (BWI), which measure the volatility of closing prices. Notice how it's gotten above 50 recently, which is quite high, but not quite up to the level reached late in 2008. It's also started turning down, which likely means we've seen the peak.

The bottom (green) plot is Normalized Average True Range (N-ATR), which evaluates volatility in terms of ranges. We can see that N-ATR has been rising over the last few months, though remains well below the late-2008 peak. It may yet keep going a bit further because of the lag effect, but it's going to take some very wide ranges to revisit the old highs.

What we have to keep in mind is that volatility tends to max out during the bottoming processes. While I can easily see the DAX falling back down toward its lows for the year, and there probably will be a lot of back and forth action, my feeling right now is that a major downside extension at this stage isn't in the cards. That gives the dollar room rally up again, but I'm not yet sure whether we're seeing a bottoming pattern there, or just a consolidation in the bigger downtrend.

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