Quote:
Originally Posted by Bertie Stemp
"While volatility surged across the markets after the US House of Representatives shot down the first vote on the $700 billion bailout plan this past Monday, the successful second attempt on Friday found a far more muted response. Looking beyond the short-term implications of this immediate event risk, risk appetite continues to plunge. Over the past week, the DailyFX Carry Trade Index plunged 1,056 points to 25,429. While there is some precedence for support back in June of 2006, the popular strategy has notably tested lows this week not seen since January of 2005. What’s more, taking a closer look at market condition indicators, it seems that fears are growing rather despite policy makers’ efforts to revive confidence in the credit market. The DailyFX Volatility Index has surged to new highs above 14 percent – levels not seen in over 10 years. What’s more, risk reversals show options traders continue to bid up protective puts as the declines in yen crosses and other popular carry-pairs gain momentum."
Hey John,
I found this in one of your recent posts on the carry trade environment, from quite recently.
I have been hearing a lot about volatility indexes recently, what does the volatility index mean to you, is it supposed to signal a reversal when it is very high?
Bertie
|
Hello Bertie,
Like most, I believe that volatility is a mean-reverting market condition. Market activity can't remain extremely high or low (unless that is the nature of the asset like natural gas or treasuries) for very long. For the currency market, there is far too much liquidity and it holds a much greater economic use than other financial assets to remain excessively volatile.
So, I would say when we hit an extreme, the markets will go back to normal - calmer. Of course, just as it is with any indicator, it is hard to define an extreme. We haven't seen this much volatility since at least 1998; but fundamental conditions are as bad as they were during the Great Depression. As such, it is possible that fear could hit the next gear - though much further would likely mean a major economy is about to fail.
As you can see from our Volatility Index below, markets are already cooling off - though they are still near historical highs.
Three to six months down the line, we could very well be in another trough for price action.
