Basic Techniques  |  DEC 1997

High Volatililty And Market Turns by William Brower, CTA

Does an increase in volatility indicate a market top? This historical look offers some insights. Back in 1994, it was exciting for traders watching the Standard & Poor’s 500 index to get a true range day of four full points or better. These days, that small a daily range is rare; instead, we are becoming accustomed to true range days that are 10 and 15 full points. Is today’s volatility unusually high by historical standards? And more important, can high volatility be used to predict major market turns? I wanted to look at data going back to the crash of 1929. I chose the Dow Jones Industrial Average (DJIA), as imperfect as it is, as my market proxy. The problem with the DJIA is that its components have changed so radically since then that it doesn’t really represent the industrial sector anymore. In addition, the DJIA may be a poor proxy for the broad market today, because momentum and index-driven funds trade DJIA stocks. Further, the large-capitalization stocks may be more volatile than the rest of the market. In fact, the DJIA can move in directions different from the broad market as measured by indices such as the NASDAQ or the Russell 2000. However, the capitalization of the DJIA is a substantial portion of the overall market. That, coupled with the longev-ity of the DJIA history, makes it one of the few indices we can use to perform long-term analysis.

by William Brower, CTA