Is the Stock Market becoming more Volatile?
Submitted by Mark on 7 August 2007 - 7:16am
Is the stock market becoming more volatile?
Last Friday's breathtaking 281 point plunge in the Dow, followed by yesterday's 286 point rise, would certainly lead us to think so. If you take a short term perspective it's hard to argue that things haven't suddenly become much more volatile more recently.
I created the chart below to give a near term perspective on stock market volatility. The chart holds 4 data plots. There are two data plots - the thin lines - and two moving average plots - the heavier lines. The thin lines are daily return absolute values. The thick lines are the 5-day moving averages of the daily returns lines. Moving average charts are simply a way to smooth out data to give you a look at near term trends.
Just look at the most recent daily return line - the thin orange line - in the chart below. This line is the daily return for DIA, my favorite proxy for the Dow Jones Industrial Average, over the past 3 months. Big spikes, both up and down, are large single day changes in closing prices for DIA.
The thin blue line, by comparison, is the daily return for DIA, over the same time period last year. This time last year we were actually just coming out from a period of volatility which was relatively higher than that we've seen recently. There is no question, however, that recent volatility has been significantly higher. And that's no surprise when you factor in all the nervousness over the mortgage lending fiasco and housing market deflation.
Taking a few steps back, however, gives a drastically different picture. Below is a chart of the Chicago Board Options Exchange Volatility Index, commonly known as the VIX. Many investors watch the VIX like a hawk, and believe it to be the ultimate indicator of stock market volatility.
This is a 5 year chart. What we see here is clearly what we can only call an upward trend in volatility. The reality is, however, the current level of volatility isn't really too far away from average. In fact it appears from the chart we're regressing to the mean, if you can apply that term to volatility.
So hang on, it looks like we're in for a wild(er) ride for a while.