Friday, October 24, 2014

What is Different About This Market?

An observation I've heard from quite a few traders about the stock market is, "Something is different about this tape."  Because these are traders with good instincts and considerable market experience, I take their observations seriously.  That led me to delve into some of the unique aspects of the present market.

The first difference was referenced in a recent blog post:  We have seen unusually strong levels of buying off the recent market lows.  Specifically, we had seven consecutive trading sessions in which my measure of Buying Pressure was a full standard deviation or more above the daily average going back to 2012.  Interestingly, the last two trading sessions have shown reduced buying interest; that's something I'm tracking closely.

The second difference is volatility, as documented in the top chart above.  When we look at 10-day realized volatility (the ten-day average of daily average true range in SPY), we can see that this market is wholly unlike what we've seen during 2014.  This has real implications for the sizing of positions and risk-taking, as stocks are likely to move more than we're accustomed to seeing.  If we look solely at implied volatility, such as VIX (the volatility implied in the options market), we are currently at levels that we saw during early 2014, around the February lows.  Realized volatility, however, is much higher.  In other words, we're seeing more market movement than even the VIX would lead us to expect.

The third difference is reflected in the bottom chart, which depicts something I call the "Power Measure".  Basically, the Power Measure is a running correlation between volatility and price change.  We're looking to see if big volatility moves are tending to occur to the upside or downside.  It is not unusual for the Power Measure to bottom ahead of intermediate-term market lows, reflecting the trajectory of downside momentum, and it is not at all unusual for it to peak ahead of price during intermediate-term bull cycles.  I use it less as a timing tool than as a general gauge to tell me if markets are moving more impulsively to the upside (Power > 0) or downside (Power < 0).  I expect us to crest in coming days, but the shorter-term version of the indicator is already peaking at a lower price high relative to September.  This makes me sensitive to the possibility that, despite the buying pressure, we could put in a lower high and correct further.  The drop we saw overnight with the NYC Ebola scare reminds us that volatility can still work both ways in this market.

The big takeaway for me is that there are limits to how much you can assume that present markets will mirror past ones.  When we see unusual price movement and wholly different volatility regimes, we are wise to not extrapolate from recent--but dissimilar--markets.

Further Reading:  Putting Direction and Volatility on Your Side Intraday