Volatility Talking Points:
- The S&P 500, Dow and Nasdaq all closed at record highs Monday as trade war headlines seemed to massage self-imposed optimism
- With holiday conditions ahead, the VIX slipped below 12 for the first time since Oct 2018, further a remarkable positioning complacency
- Growth concerns were conveniently overlooked and monetary policy will be a talking point Tuesday, while the Dollar hosts a heavy docket
What do the DailyFX Analysts expect from the Dollar, Euro, Equities, Oil and more through the 4Q 2019? Download forecasts for these assets and more with technical and fundamental insight from the DailyFX Trading Guides page.
Extreme Inactivity Levels Stretching Into Record Territory
There is no missing the anticipation preceding the holiday liquidity drain through the final 48 hours of this trading week. The moderation of activity levels in the major asset classes and regions around the world is pushing actual volatility readings to extremes and in some cases record lows. For the VIX volatility index derived from the S&P 500, that translated into a further slide below 12 this past session to clear out the functional technical floor stretching back to October 2018. There is still the extraordinary stretch of full-blown willful ignorance through the second half of 2017, that we are unlikely to replicate given the relatively fresh bouts of sharp rebalancing in February and 4Q 2018; but our circumstances still rival that period. In particular, the stretch to record highs for the S&P 500 and Dow.
Chart of VIX Volatility Index (Daily)
Chart Created with TradingView Platform
As a benchmark for risk appetite and a favorite representation of 'the market' for many, the progress of the S&P 500 is a frequent focus in the debate between complacency and simple bull market. However, this is not the only area of the financial system that is experiencing extraordinary restraint. Statistically-speaking, EURUSD is facing far more impressive conditions. We have seen a remarkably controlled descent from the benchmark pair - eliciting critique from the US President along the way - over the past 18 months. Yet, in the background, the conditions have been even more remarkable. As of this past session, the EURUSD's daily range dropped to a multi-year low. The pair's 1-week implied (expected) volatility reading hit a record low. What's more, the 20-day (1 trading month) average true range would also hit its lowest since the Euro began officially trading back in January 1999.
Chart of EURUSD with 200-Day Moving Average and 20-Day ATR (Daily)
Chart Created with IG Charts
It is possible to see this incredible quiet in the environment stretch further, but it is also inevitable that normally functioning markets will return to a more practical normal. For those that think that this is the new normal because of an economic renaissance or monetary policy, I would suggest hedging your risk. While the 'structural' (long-term) inactivity is at risk of rebalancing in the foreseeable future, there is a well-known 'seasonal' (short-term) caveat that can help restrict the disorderly reversion to a mean through the rest of the week in the form of the US Thanksgiving holiday. When such forces can bolster the probability of a certain backdrop, it is worthy of strategy.
What Strategy Type Best Suits the Market Conditions We Are Facing?
It should surprise no one that most market participants seek volatility. With a charged backdrop, traders’ fantasy of larger and faster returns; when the reality is more erratic performance that is indeed accelerated. When faced with a lack of intensity, many will stay on the sidelines, but the greater risk is from those that attempt to keep in pursuit of volatility where it is rare. In practical terms, those traders are trying to chase low probability setups with a strategy not adapted to prevailing conditions. If our market landscape is restricted volatility and difficulty in leveraging fundamental developments, that would make trends particularly difficult to fuel and breakouts more likely to stall quickly after the technical spark. Even the S&P 500 for the former example has been a slow progress and there are plenty tech patterns like USDJPY's that have seen a breakout attempt fail.
Chart of S&P 500 with Ratio of 10 Day to 30 Day ATR (Daily)
Chart Created with TradingView Platform
The more appropriate approach given these conditions would be a range strategy. That is not to say all markets are well positioned for range trades, but those areas where the technicals and fundamental align to that undercurrent are worthy of a closer look. As it happens, there are very similar elements between breakout and range types with the potency of conviction standing as the differentiating factor. The difficulty through the rest of this week is mustering enough volatility to make for a substantive enough range. Holding out for a wide swing may require exposure for far longer than the market is reasonable. Though a sudden eruption of volatility may not be in the cards this week, the longer we have to hold for a moderate move, the greater the probability.
Markets and Pairs Better Suited to the Systemic-Seasonal Activity Convergence
Looking out over the financial system, seeking out range conditions among the major asset classes should first lead us to appreciate the prevailing winds behind underlying risk trends. This has lead to a significant stretch on the US indices which do not have an easy range to traverse. Pushing fresh record highs seems to be the default, but tempo even with liquidity fully accessible has proven difficult. And, while 'rest of world' equities (VEU) are not pushing their own record highs, they are still close to their respective recent highs In contrast, the EEM emerging market ETF and HYG junk bond ETFs are well within their respective ranges.
Chart of EEM Emerging Market ETF with Ratio of 10-Day ATR to 10-Day Range (Daily)
In the FX market, I am still partial to EURUSD through the short term. It is leaning on 1.1000 support which is a Fib established over the past few months that coincides with a range support. A path of least resistance would support a swing higher. Given that the backdrop for volatility is so extreme, a reversal may be throttled, but there remains potential. Meanwhile, USDJPY, NZDJPY and GBPJPY have intense short-term breakout conditions but such resolution may support a technical charge that ultimately supports range - or a nonstarter break in the opposite direction. There are a host of Sterling pairs that have borrowed some notable volatility from polls around the upcoming election which can help to bolster moves within well-established congestion patterns from the likes of GBPUSD, GBPNZD and even EURGBP.
Chart of GBPUSD with CME’s Pound Volatility Index (Daily)
Chart Created with TradingView Platform
If you want to download my Manic-Crisis calendar, you can find the updated file here.
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