Market commentary of late has been awash with the use of the word volatility and to flog a dead horse most of the people using the word are using it incorrectly. This misuse is generally a function of ignorance – most who comment on volatility don’t understand what it means.
Defined simply volatility is the speed and magnitude of movement – it is a relative measure that is calculated over a given period.
Consider the chart below of the S&P/ASX200 on this chart I have plotted the 15-day historical volatility. On the historical volatility chart, I have added the average volatility for the past year.
To say that markets are currently more volatile is not supported by the data. Volatility levels are just above the average volatility for the previous year and certainly well below other periods during the year.
This does raise the question as to why market commentators make these sorts of pronouncements. As I said earlier part of the answer lies in ignorance. Most do not know what the definition of volatility is nor its application. The standard level of understanding revolves around the assumption that the market has moved, when it moved it moved down and then up. Therefore it must be volatile.
However, I think there is an extension to this explanation. markets can exhibit periods where they generate a lot of noise and it is difficult to define a signal from within this noise. This apparent dirtiness generates an emotional response in traders and they automatically default that there must be something wrong with the market because my approach is not generating a clean signal. The most obvious culprit must be that the market is more volatile. This emotional response is probably heightened by the nonsensical approach of the current White House in issuing policy by decree as opposed to reasoned thought.
The response of traders to their inability to see signals within noise is a misunderstanding of how systems trading works. Sometimes, there are no signals simply as a function of the market’s price distribution. This reflects an immaturity in the system or the understanding of how systems work.
Sometimes there is only noise and no signal – this is just the way the world works.