So what is the emotional significance of the volatility of volatility? When volatility itself becomes volatile, emotional stability is itself unstable: we swing abnormally between calm and arousal. It may well be the case that the volatility of volatility is more important to performance--market performance and trading performance--than volatility per se. If we are in a stable volatility regime, we can adapt to low or high levels of market movement. But if volatility itself is moving around, adaptation becomes far more tricky.
Above is a volatility of volatility measure based upon pure volatility (volatility per unit of trading volume) from November, 2013 to the present. Note how we are in a far different vol of vol regime than in the recent past. This also shows up on traditional measures of volatility of volatility, such as $VVIX.
When pure volatility is in its lowest quartile and volatility of volatility is low, the next three days in ES have averaged a loss of -.25%. When pure volatility is in its lowest quartile and vol of vol is high, the next four days in ES have averaged a loss of -.02%.
When pure volatility is in its highest quartile and vol of vol is low, the next three days in ES have averaged a loss of -.27%. When pure volatility is in its highest quartile and vol of vol is high, the next three days in ES have averaged a *gain* of +.77%.
Like I said, it may well be the case that vol of vol--and not just volatility--is key to market performance and trading performance. When we have had volatile markets and volatility itself has been volatile, those markets have provided the best upside returns.
Do we have ways of adapting, not only to volatility, but to volatility of volatility? In our trading? In our self-management?
New promising answers come from asking new, promising questions.
Further Reading: Pure Volatility
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