The S&P 500 has continued its slow grind higher throughout much of 2017, gaining another 9 percent year-to-date. While the steady “melt-up” in the stock market this year has been great for long-term investors, the lack of market volatility has created a challenging environment for traders.
Volatility is a measure of the magnitude of the moves the stock market makes in a given time period. In essence, it’s a representation of how much risk the market holds on any particular day.
Mathematically, volatility is measured as the standard deviation, or variance, among returns over a given period. Markets or stocks that make steady, small moves have low volatility, while markets that make violent swings are high-volatility.
U.S. stock investors often use the CBOE Volatility Index, which trades under the symbol VIX, as a gauge of stock market volatility. The VIX is a measure of implied forward 30-day volatility of the market based on at-the-money put and call S&P 500 index option prices. As of late July, the VIX was trading at its lowest levels since 1993, suggesting volatility has completely disappeared from the market.
The S&P 500 seems to have lulled investors to sleep in 2017. Through the first half of the year, the S&P 500 only logged four days of daily gains or losses of at least 1 percent. Recent headlines about geopolitical unrest related to Russia and North Korea, as well as news out of Washington that the healthcare market and pro-business agenda of the Republican Party is in disarray hasn’t really moved the market. Since the threat of a potential nuclear war didn’t spook investors, traders have grown even more confident that they can remove their hedges and expect not to get burned.
Trading during periods of low volatility can be a challenge. In fact, most of the largest U.S. investment banks blamed low market volatility for disappointing trading revenues in the most recent quarter.
Traders take advantage of large swings in the market, and the more a market is moving, the more opportunities there are to profit. But while the opportunities may not be as large in a low-volatility market, calmer waters have their advantages.
The biggest advantage to trading in a low-volatility market is predictability. There may not be many large daily swings in the market, but that doesn’t mean that stocks have not been moving.
In fact, there are 31 stocks in the S&P 500 that are up at least 40 percent in 2017 and 10 more that are down at least that much. Traders may not get much out of day trading these stocks. But if they increase their trading horizon from a day-to-day time frame to a week-to-week time frame, market moves in a low-volatility market can be much more predictable and have much less costly noise.
There are still also plenty of large daily trading opportunities out there, but they may require a bit more digging to identify. Traders must rely on market catalysts such as earnings reports and news items to trigger short-term volatility for particular stocks. Another place to find daily volatility in a calm market is to look away from large-cap stocks and toward small- and mid-cap names, which tend to have less market liquidity and much higher volatility.
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