Tuesday, June 20, 2006

Intraday Volatility: What We Can Learn From Volume Patterns

We are seeing enhanced volatility at every time frame during this recent market decline. In today's entry for the Trading Psychology Weblog, I posted a chart that showed how dramatically the VIX itself has become more volatile on a day-to-day basis.

Intraday, from March through the end of April, the average 15-minute range in the ES futures was 2.2 points. From May through June 15th, the average 15-minute range was 2.9 points. The average three-hour range from March through April was .59%. Since May, it has been .81%.

Why is volatility greater? Perhaps it is a function of *who* is in the marketplace. From March through April, the average 15-minute ES volume was 30,330. Since May, it has been 40,911. We've been hearing how "fast money" hedge funds and other money managers have been liquidating volatile positions during this time. Maybe, just maybe, we're seeing 33% more volume and similar higher volatility because of *their* enhanced participation.

I look at it this way. The locals participate every day in the market. The average daily volume probably represents their normal participation in the marketplace. When volume--and hence volatility--spike above normal, that's probably because other time-frame participants have come to the market: mutual funds, hedge funds, investment banks, etc. They only come to market when they perceive relative value or overvalue in an asset class.

By looking at volume that way, you can figure out the price points at which these savvy players discern value--and overvalue. You can also figure out where those value points are shifting and where they remain in force as mean values for eventual reversion. Remember: locals provide liquidity and govern the next few ticks; institutions provide market direction over the next few days. How many traders get stopped out of good positions because they lose a few ticks to the locals and lose sight of the market's bigger picture determined by other-timeframe participants?


Paulo de León said...

This change in tempo is puzzling. Is like you are driving comfortably in a country side road and all of a sudden you are in a 5 lane highway.
Another example of Everchanging cycles.
I do believe that this is probably the end of the low volatility cycle. Those who learn to trade in this low volatility enviroment are stopped out. The stops are function of the most recent volatility, the profit target too.
My question is how will be the volatility once the dust settles?
We´ll see.

Brett Steenbarger, Ph.D. said...

That's a very good point, Paulo. The traders experiencing the greatest difficulty, I find, are those who do not adjust their position sizes and stops to account for the change in volatility. I have had to widen out my stops, trade more selectively, and scale into positions more than in the past. Thanks for the note.