Current Low Volatility Forecasting a High Volatility Future

May 4, 2015: 11:49 AM CST

If you’re finding the current low volatility environment boring or lackluster, wait a few more days or weeks!

The Bollinger Band/Sigma Volatility Chart model is suggesting a near-term spike in Volatility.

Let’s update the chart of the S&P 500 and note what’s happened and what’s likely to happen next:

If you’ve been trading for any length of time, you’re likely aware that Volatility is easier to “predict” than Direction.

One of the foundational price principles states that Price Alternates Between Range Expansion (trend/impulse movement) and Range Contraction (sideways/consolidation movement).

Low volatility environments (like the one we’re seeing now) eventually give way to high volatility environments.

One of the ways to view volatility in price (among the many options) is to use the Standard Deviation function calculated in Bollinger Bands.

The chart above shows the S&P 500 with “Four Sigma” or Four Standard Deviations (Bollinger Bands) above and beneath the mean (average – blue).

The blue lower panel indicator is the “Bollinger Band Width” measure which subtracts the upper fourth standard deviation from the lower fourth standard deviation.

The current “Bollinger Band Width” is 96.44 points, meaning there are 96 S&P 500 points between the top fourth and the bottom fourth standard deviation from the mean.

Note that this is among the lowest readings in the chart and the highest reading here – observed in November – was above 450.

You can visually see the clear “wave” or up/down/up/down/up pattern (high/low/high/low) in this indicator.

So what is the current situation and what is likely to be the future?

The Yellow Highlights draw your attention to the previous periods of low relative volatility as indicated by compressions in the Bollinger Bands.

Compare each event and the immediate future outcome.

Each time price compressed into a visual low volatility environment, a breakout and impulse (price moving multiple days in the same direction) occurred following the compression.

Sometimes the movement was up and sometimes the movement was down; again, volatility is easier to “predict” than direction.

The current reading suggests that we may have a few more days of compression or low volatility conditions ahead of a likely future expansion in volatility and thus multiple-day movement in the same direction.

We can visualize an upside breakout triggering stop-losses of the short-sellers, resulting in a powerful short-squeeze like that of May and November 2014 and then February 2015.

However, a downside break and increase in volatility to the sell-side opens a bearish expansion price pathway like that of February, April, July, and October 2014.

Higher volatility environments provide opportunities that lower volatility environments do not.

Be sure to distinguish the volatility environment and note which types of trading strategies favor a specific environment.

Don’t get trapped using the wrong strategy for the wrong environment!

Before we conclude the post, let’s highlight a similar chart of the Dow Jones Industrial Average:

Again, we see the lower volatility environments (lows in the blue Bollinger Band Width indicator) giving way to higher volatility environments.

Logically, higher volatility environments eventually settle down to lower volatility environments.

Continue monitoring the current range/low volatility situation and be prepared for a likely shift into a higher volatility situation in the near future.

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Corey Rosenbloom, CMT
Afraid to Trade.com

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4 Comments

4 Responses to “Current Low Volatility Forecasting a High Volatility Future”

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  2. A Quick Way to Chart the Cycles in Volatility (We're Moving from Low to High Now) | Afraid to Trade.com Blog Says:

    […] a look at my prior post “Current Volatility Environment Forecasting a Higher Volatility Environment” and this morning’s update “Still on Breakout Watch for the S&P […]

  3. Updating Sigma Band Volatility Chart of the SP500 | Afraid to Trade.com Blog Says:

    […] “Current Low Volatility Environment Forecasting a High Volatility Future” […]

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