It's Back—Volatility That Is

10/10/2014 2:50 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Even though the market plunge caught many by surprise, MoneyShow’s Jim Jubak thinks it’s crucial to remember that volatility begets volatility, which means that volatility may continue to increase over the next few weeks.

What’s up with the huge swings in this market?

As you try to figure that out amidst the bellows of the Wall Street herd, remember that volatility begets volatility. The rapid increase in stock market volatility just about guarantees that volatility will continue to increase over the next few weeks.

Partly that’s a result of the extraordinarily low volatility of the last few months. The Standard & Poor’s 500 (SPX) went through all of May, June, and July without a single move of more than 1% in either direction. In contrast, we’ve had five single-day moves of more than 1% in the first seven days of October. No wonder that the CBOE Volatility Index, the VIX, which had been flirting with the low end of its historic range, has bounced back to 18.8, a 21% increase in what is commonly called “The Fear Index.” The VIX hit its 2014 high back on February 3 at 21.44. (The VIX is a measure of demand for options on the S&P 500 index. The demand for options increases when investors expect more—and larger—market moves.)

Technical analysts chart the VIX just as they do individual stocks and market indexes. Right fails to hold near 18. A rise to 21 in the VIX would likely mean a drop of another couple of hundred points in the S&P 500.

After reading that, you can start to get a sense of how volatility begets volatility. As more investors decide to hedge against a market decline, they send the VIX higher. A higher VIX then adds to the argument that volatility is on the march and that the smart move to is to buy more options to hedge on a further decline in the S&P 500. Which, of course, then sends the VIX higher.

The rise in the VIX even ties in with my argument yesterday in my post that the markets have lost faith in the power of central banks to support asset prices. I’ve heard a number of commentators—on the rise in the VIX—say something like “This volatility is what was normal in the days before the central banks intervened in the markets.”

Another part of the increase in volatility is an increase in trading volume. In the early going today, October 10, for example, trading volume in shares of the S&P 500 companies was 81% higher than the 30-day average for this time of day, according to Bloomberg.

As of 1:00 PM New York time today, the Dow Industrial Average was up 0.14%; the S&P 500 was ahead 0.03%; and the small-cap Russell 2000 was higher by 0.17%. Technology shares are getting clobbered today and the NASDAQ Composite is off 0.83% with some analysts starting to talk about an industry correction.
 

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