How slow has the stock market gotten?
Answer: All time extremes in slow.
Volatility, daily ranges, and even volume have all fallen to levels not seen in years. If you’ve been observant enough to notice these significant abnormalities, then you are certainly not alone.
Case in point: On Friday, June 20, it was options expiration date for the second quarter, a typically very volatile day, but not this one.
With 2.8 billion shares traded on the S&P 500 (NYSEARCA:SPY) last Friday, versus the 200-day volume moving average of 2.1 billion, one would expect higher volatility, but this was not so.
Instead, on one of the most historically volatile (NYSEARCA:VIXY) days of the year, stocks had one of their quietest days since derivatives were created!
Average True Range
There are many ways to measure volatility, but one of my favorites is the average true range (ATR), otherwise known as the “maximum distance traveled”.
The ATR is pretty simple. The indicator looks at the market’s price high and price low for the period, subtract one from the other, and reveal the distance the market traveled at its extremes.
Here are the S&P 500′s price stats from Friday’s options expiration:
The S&P”s (NYSEARCA:IVV) average true range for Friday was only 4.74 points, or just 0.2%, continuing the trend of extremely low volatility and price moves in the equity market and setting a record.
Why it Matters
One might reasonably respond, “so what”, and wonder why it matters since stocks keeps rising. But that is exactly why it matters.
Periods of such extremely low volatility (NYSEARCA:VXX) occur closer and more frequently to market tops than they do bottoms.
A look back at history sounds the same message and the chart I provided to our subscribers at ETFguide proves this much. (See below)
The chart is admittedly busy, but that is because it contains a lot of meaningful data points. On it is a graph of the S&P 500 (in red) overlaid with the five day moving average of the average true range (in black).
In blue are the dates identified when the five day ATR fell below 10 S&P points. Called out in red, most of those times occurred when the S&P (NYSEARCA:BIB) was nearing or making some sort of tradable top. Every major top of the last five years (2010, 2011, and 2012’s peaks) also saw its ATR fall below 10 points, warning of such a trend change, just as is occurring now.
Contrary, as shown by the spikes in the ATR indicator (highlighted in black), the market’s daily range becomes much larger nearer market bottoms, far from where we reside today.
This makes sense as volatility (NYSEARCA:SPLV) typically picks up during market declines and slows during market tops. The low ATR right now is a warning sign that the markets are likely near at least a short term top, but potentially a sizable one as occurred in 2010 and 2011.
Is This Time Really Different?
Check out the following table showing the S&P’s average true range history. June’s average daily range (highlighted in green) is at the bottom of an almost 25 year history.
The question that should be asked is, do we really think June, the year 2014, or even the 2013-2014 timeframe should be used as the new volatility standard?
Or, should we assume that this time is not different, that mean reversion will happen, that volatility right now is indeed low, and that the markets will revert to reflect their long term daily trend above 1%?
Most investors know one of the worst mistakes one can make is assuming “this time is different”. Even the 1990′s bull market (SNP:^GSPC) had average daily ranges of 1.1%. At a minimum I think we should assume stock market volatility (NYSEARCA:SCHB) will again pick up at least back to that average (double what it is today).
Combining the currently low average true range levels, which have typically accompanied market tops, not market bottoms, with the fact that long term average volatility is over two times what it is today (even in the 1990′s bull market), investors should be ready for a pickup in volatility, likely caused by a market pullback rather than a continued rally as the average true range indicator shows.
Don’t get lulled to sleep by the lack of volatility. Sure as the sun rises and sets every single day, volatility will rise.
The ETF Profit Strategy Newsletter combines common sense analysis with technical, fundamental, and sentiment strategies to keep investors ahead of major trends in financial markets. We track average true range along with other key indicators to help our readers profit from changing market conditions. History suggests a major reversal in volatility is ahead. Will you be ready?