Rather than start from a technical analysis or evaluation of theme and event risk, the best place to start your trade evaluations is an appreciation of more foundational considerations of the market. How is volatility and participation staging these next two weeks?
Talking Points:
- Volatility is extremely low, even by seasonal standards - and that should keep us on our guard
- VIX has closed below 10 for 50 days so far in 2017 and the 52-week average of the index is at a record low 11.1
- The final two weeks of the year are historical extremely quiet, but this time of reflection may set up a serious turn in 2018
Breakouts and trends are extremely uncommon in current market conditions. Standard are measured ranges with draw nearer targets and stops for traders. But that is exactly the conditions best suited to retail traders. See how these traders are positioning on pairs like USD/CAD and AUD/USD on the DailyFX Sentiment page.
Unless you've been away from the markets all year, you are already familiar with the fact that volatility is extremely low. In fact, it is at unprecedented levels by many different measures. While many of us start our search for trade opportunities by looking for the most loaded technical pattern or laying out plans for high profile event risk, the most important starting point for our analysis is market conditions. Do activity levels and participation seem capable of offering the heavy lifting necessary to fostering larger and more difficult developments like extending or reversing mature trends? How about generating a key breakout with strong follow through? Or are these critical features of the system only conducive for processing measured moves within ranges and quick-to-deflate breakouts? Answering those questions from the jump puts us in the best position to filter reasonable trades.
Looking at volatility, we are left with an immediate impression of what type of trades we should be pursuing - especially over these final two weeks of the year. Taking stock of the favorite volatility measure - the VIX Index - we are faced with extremes. Even before taking into account the seasonal norm of the final two weeks representing one of the thinnest and least active periods of the year, our activity levels are unprecedentedly low. In fact, a measure for the entire year, we find the 52-week moving average of the VIX is currently standing at 11.1 - indicating that not only are we at unparalleled levels of quiet but it has persisted far longer than any other time over the 27 years the index has been tracked. Another means of looking at this is the tally of days the VIX has closed below 10. As of Friday's close, it was 50 days which is equivalent to approximately 20 percent of the year. There are only two other clusters of incidences in the past that the indicator has gotten this low for a few days and those were explicitly holiday periods of 2006 and 1993. In other words, conditions are extremely quiet - almost certainly, too quiet.
There are health and unhealthy reasons for activity levels to be low - and inversely for markets to outperform. The 'right' reasons for volatility to be very low in the financial markets is a particularly robust economic performance and outlook, movement towards deeper globalization, strong circulation of capital in local and global systems, and steadily rising rates of return. We are clearly not checking off these boxes. Alternatively, the 'wrong' reasons to see volatility deflate to extremely low levels can be unique to the situation; and currently that motivation is the presence of the strong outside forces of global central banks. Massive stimulus programs have provided a sense of confidence that a supranatural entity will save us from our poor investments, but truly this is a situation where markets are forced to stretch for returns due to the utter lack of income. So they find it in capital gains and lower their use of hedges for safety because it is too expensive. This is an unstable environment. Yet, we are unlikely to reconcile this to realistic terms in 2017. Seasonal curbs will have their influence; but during this time, there will be a period of reflection. Will traders and investors be this bold and complacent when liquidity returns in 2018? We discuss the nature and importance of volatility through the end of the year and start of the next in this weekend Quick Takes Video.
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