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Putting Recent Volatility Into Historical Perspective – Part II

(Guest Commentary By Bill Rempel – October 30, 2008)

Dear Subscribers and Readers,

For those who had wanted to learn more about individual stocks, the art of stock selection, and model-based trading/investing, it is time to turn to one of our regular guest commentators, Bill Rempel.  Bill is a prolific writing on the financial markets and trading strategies and is the author of a very active market blog at: http://billrempel.com (“The Rempel Report”).  Bill usually writes for us on the first Thursday morning of the month – but he has been kind enough to “stand in” for me as I am currently studying for my mid-term examinations (as many of you should know, I just enrolled in the UCLA Anderson MBA program this year).

In this commentary, Bill is going to put the current volatility in the stock market (namely the Dow Industrials and the S&P 500) in historical perspective.  It is effectively an update on his April 3, 2008 commentary.  At the time, Bill commented that while the stock markets during January to March 2008 were undoubtedly volatile, it still remained tame relative to the volatility experienced during past bear markets.  Since then, however, the game has definitely changed.  Measured by indicators such as the “Average True Range,” recent volatility during October has been truly historic – even taking into account the massive volatility experienced during October 1987 and the September 1929 to July 1932 bear market.  Without further ado, following is a biography of Bill:

Bill Rempel (aka nodoodahs) is an active poster on the MarketThoughts forum as well as a few others around the web. Bill is a regular, monthly guest commentator on our website (see “The Correlations, They Are A-Changin'” for his last guest commentary). Bill graduated from Caddo Magnet High School (a high school for nerds) back in 1985 and proceeded to learn the hard way when he drank his way out of a scholarship to Tulane later that year. After a few years of sweating for a living, he decided to go back to school, and graduated from LSU-Shreveport in 1995 with a Bachelors in Mathematics - all the while working the overnight shift stocking shelves in a grocery store.

Post-college, Bill has been in the P&C insurance industry as an actuary, product manager, and pricing manager. Bill and his wife Millie are amateur investors with a variety of holdings, but they prefer to buy and hold value investments. In typical "value" style, they live cheap, driving old cars and preferring to save or invest instead of buying fancy "stuff."

Disclaimer: This commentary is solely meant for education purposes and is not intended as investment advice.  Please note that the opinions expressed in this commentary are those of the individual author and do not necessarily represent the opinion of MarketThoughts LLC or its management.


In many ways, this is "Part II" of an attempt to put 2008's stock market into perspective; "Part I" wasn't intended to be anything other than a stand-alone article when I wrote it in April; but here we are!

Some computational notes:

- the link between EZ Trend and volatility has been established many times, including six months ago; it is not revisited

- the percentage of days which move 2% close-to-close seems almost quaint; not revisited

- instead of the standard deviation of daily close-to-close moves, I will use the average of the absolute value of the daily moves; this should be easier to intuitively grasp, as most people would come to grips with 2% moves on average faster than they would a standard deviation of moves.  I will call this the average daily move (ADM).

- where possible, I will use the average true range as a measurement.  This will differ from the typical indicator (ATR) in that I will use a straight average and not an exponential moving average, but otherwise it's identical.  The "true range" of a day's movement is the maximum of the high minus the low, the high minus yesterday's close, and yesterday's close minus the lows. It incorporates both the intraday volatility as well as any morning gaps.  It's not always possible to use the ATR historically, because for older time series, one often only has daily closing data and not the open, high, or low.

- to put the ATR and ADM into context, I will use the average closing price for the same time period as the denominator.  For example, if the ATR is 10 over some 1-month time period, and the average closing price over that same time is 1000, then I might say the ATR/close is averaging 1% for that period.

- finally, for some time periods I will look at the range from minimum to maximum closing price, and call it "Range," for lack of a better word.  It will be the maximum close during the period, divided by the low close, minus one, in percentage.  A monthly high and low of 110 and 100 would be a "Range" of 10%.

Here are the top 20 years in terms of ATR/Close volatility; note that I have data (including some reconstructed data) for the Dow from 1901 (but only OHLC data from 1928) and for the S&P 500 from 1950 (same note about reconstructed data, only OHLC from 1962).  That's why, even though there's a high correlation between the indices, the top twenty is different for the two.

Dow Jones Industrial Average and S&P 500 Index - Top 20 years in terms of ATR/Close volatility

From this perspective, it looks as if year-to-date 2008 is the second most volatile year in the history of the S&P 500; perhaps the MOST volatile year, if you used the average daily move (ADM/Close) as your benchmark.  Considering that, over the long term, average daily moves in either index are normally on the order of 7/10ths of a percentage point, it's plain to see that 2008 has been a wacky year.

When we have the longer historical perspective of the DJIA, we can see that the crash years of 1929 and 2000, and several of the early Depression years, actually had higher volatility than 2008 did.  It's also instructive to see where the Recession of 1975, the Asian Contagion, the collapse of LTCM, and the Crash of 1987 fall on this list.

So how does October of 2008 look?  Yes, the month isn't finished yet, but it's close enough to compare. 

Dow Jones Industrial Average and S&P 500 Index - October 2008 compared with historic ATR/Close volatility

From the limited time perspective of the S&P 500, it's hardly even a contest.  Only the Crash of 1987 has a higher max/min range than October of 2008, and no other month comes close in terms of ATR or ADM volatility.  The AVERAGE DAILY MOVE is 4%.  Awesome.  If you've still got money to trade and you're still considering trading, give yourself a hand.

Now in the longer historical perspective of the Dow Jones, we can see that October 2008 is still one for the ages, but it's not quite the WORST.MONTH.EVER.  In terms of intraday volatility (ATR) it was number one with a bullet, but from a day-to-day perspective, 1929 was worse and several other months were close.  In terms of max/min range, no less than four other months topped October of 2008; only one of those months was in the "modern" era, the others all date back to the Big Crash and the Depression.

From the perspective of the Dow, take a look at the following graph:

Dow Jones Monthly Volatility - ADM/Close and ATR/Close

There is no OHLC data, and therefore no ATR/Close calculation, for the Dow before late in 1928.  The "steady-state" normal movement from close to close is about 7/10ths of a percent.  One oddity is that the ATR/Close appears to be in an uptrend for the Dow, over the past half-century; I think this is a function of the index weighting and not a market-driven phenomenon, however.  We can see that October 2008 is right up there with many of the most volatile months in history. 

Here's a chart of the Dow's monthly range, defined as max close / min close, minus one, in percentage.

Dow Jones Monthly Volatility - Range

As bad as October 2008 has been, here it's plain to see that other months have been worse, from a volatility perspective defined by monthly range.

Here's the monthly range for the S&P 500, on the same scale, but a shorter timeframe.

S&P 500 Volatility - Range

In the shorter timeframe, only the month of October 1987 shows up as worse.  Note that the Dow reached up into the 50% range, whereas the S&P 500 hasn't ... yet.

And here is the ATR/Close and ADM/Close chart for the S&P 500.

S&P 500 Volatility - ADM/Close and ATR/Close

On the same scale as the Dow chart, above, there are two different points to note.

First, the S&P is not nearly as volatile as the Dow, from 1950 to 2008.  This is to be expected, from an index with 17 times as many constituents. 

Second, the S&P does not show the overall trend up in ATR/Close that the Dow does.  I suspect, but can't prove, that it's due to the price-weighting of the Dow and the changes in it's weighting factors as the stocks have split and been replaced over the years.  That does imply, however, that day traders might be better off playing the Dow contract and not the ES - unless they have size that demands a great deal of liquidity.

In many ways, "Part II" is the same as Part I," but with a slightly different conclusion; recent volatility HAS been historic.

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