Just a high level perspective on what we have going on in a few major markets this week. In general, most markets are in some kind of volatility compression. Volatility compression is a term that basically means current volatility conditions are low, relative to more “normal” volatility for each specific market. There are many ways to measure this (and some traditional chart patterns capture volatility compression very well), but a few general points to consider:
- It’s easy to lose track of quiet markets. People get bored and stop paying attention. The media stop talking about quiet markets (because quiet markets are boring). If you’re a trader, you cannot afford to lose track of quiet markets. Do the work every day, and watch for breakouts.
- Volatility compression can be thought of as “coiled potential”–when the market eventually moves, there is a higher chance of a sharp momentum move. Another way to say the same thing is that mean reversion tends to be muted when markets come out of volatility compression.
- From a practical perspective, at the very least, you do not fade the first move out of volatility compression. This is an environment where breakout trades tend to work, so don’t put yourself on the wrong side of that trade.
- If you are a trader (as I am) who sizes trades based on current volatility, realize that tomorrow’s volatility can be some whole number multiple of today’s. In other words, that position that feels good today may be terrifyingly over-sized tomorrow. There are ways to deal with this, but they all involve tradeoffs.
Whatever we’re looking at: stocks, oil, gold, (most) rates, (many) currencies–we find quiet markets that may appear boring, at first, but this placidity hides tremendous potential and significant risk. We say all that time that part of your job as a trader is to stand apart from the crowd. This–paying attention to quiet markets, not acting too soon, but acting on the correct triggers–is an important and, perhaps, under-appreciated way that a skilled trader must stand apart from the crowd.