Over the last 3 months we have seen a marked pick-up in volatility. This reflects the widely divergent views market participants have over the future outlook for both equities and the broader economic landscape for the near-to-medium term.
Volatility offers the perfect environment for CFD traders to potentially profit from rising and falling markets.
What’s causing the current volatility?
For much of 2010, investors have been plagued by fears and uncertainties surrounding European sovereign debt levels, Chinese growth trajectory, the US economic recovery and more recently Australia’s outlook with the government leadership change and the proposed resources tax (RSPT). Throw into the mix some end of financial year tax loss selling and you can see why markets have been so turbulent of late. We can only expect to see volatility begin to subside when markets move definitively past some of the issues above and a more unanimous path is agreed upon.
Looking at the past year, it has been a choppy and emotional ride with traders having to adapt to changing conditions and sentiment in different asset classes. We have seen volatility pick up and recede as governments try their best to convince the equity, debt and forex community that they have their fiscal houses in order. During these times, it’s far more important to have the flexibility to adapt, than the ability to predict future moves. Looking at how changes in sentiment can lead to these moves is key to executing winning trades. Measuring sentiment is vital here and can be done in different ways.
Volatility Index
The VIX or Volatility Index (well known as the ‘fear index’) is a popular measure of implied volatility of S&P 500 index options. It has been rallying of late as the cost of protection or buying puts have increased. When market participants get nervous about a possible negative event, not only do traders often look to close out of long share positions, but they can effectively limit any losses by selling put options against it.
In October 2008, around Lehman’s collapse, we saw the VIX spike up to 90 as panic and fear was rife. During this time, we also saw some of the most volatile moves. After periods of renewed confidence earlier this year, the index has spiked to around 50 in the last couple of months and now sits in the mid 30’s. This shows that traders are still nervous and indicates volatility could be with us for the foreseeable future.
Volatility in Australia
Here in Australia whilst we do not have an actual index that measures the volatility, it can easily be measured by looking at the weekly trading range (weekly intraday high and low). Recently we’ve seen another pick up in the range symbolising that traders are reacting more aggressively to news flow. This can be measured if we take the average opening and closing price of all the stocks in the All Ordinaries (XJI). The average daily move as it stands is 1.87% and in early June it was about 1.4%, so it has been on the rise again. Although in late May, we saw real volatility of around 4%!
The Australian market has really been thrown about by overseas markets and the real fear that a global slowdown will effect economic growth. Recent price action on the ASX 200 saw the index rally in May, however recently traders have become more pessimistic. From 21 June, the bears have taken control and we’ve seen a sharp sell off as concerns remain in the macro environment. The moves have probably been exaggerated by the poor volumes as some traders have gone into cash until more answers on Europe have been provided.
The Australian market closed out the financial year up 8.8%, which is a reasonable performance. However, compared to other global bourses, such as the Dax +24%, Kospi +22.2% and Dow Jones + 17%, it has underperformed.
The Australian market moving forward in volatile times
Longer-term money managers may shy away from equities until the recent volitilty subsides and look to keep their powder dry until things settle down. They may also be relatively cautious given the number of companies that have downgraded profit expectations; this is why the upcoming reporting seasons, here and in the US, are so important. Whilst price earnings (P/E) ratios have pulled back to some very compelling levels with the ASX 200 trading on 11.5x forward earning, a 20% discount to its long-running average, we need to see a robust earnings outlook to justify analyst expectations. Keep an eye on companies that provide positive advice on their outlook as they will find good buying support.
Manage your risk
Until we get clarity on the reporting season and other macro issues subside, short-term traders can take advantage of the high market volatility to potentially make significant profits. However, it is also important to have a stringent risk management strategy in place and keep a disciplined approach to each and every trade. With IG Markets you can take steps to limit losses while ensuring that potential profits are uncapped. Find out how we can help you to manage your risk.
During periods of marked volatility, you can profit from rising or falling markets by trading CFDs. At IG Markets, we offer a range of CFD markets to go long or short.
To see how you can make the most of these turbulent times, view our free online seminar.
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Updated:07/07/10
Disclaimer: The above material does not contain (and should not be construed as containing) personal financial or investment advice or other recommendations. The information provided does not take into account your particular investment objectives, financial situation or investment needs. You should assess whether the information provided is appropriate to your particular investment objectives, financial situation and investment needs. You should do this before making an investment decision based on the material above. You can either make this assessment yourself or seek the assistance of an independent financial advisor. IG Markets Limited accepts no responsibility for any use that may be made of these comments and for any consequences that result.
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