Knowing What No One Knows About Volatility
To know what everyone knows is to know nothing.
An old floor trader told me that many years ago. He said it helped him avoid getting caught in manias. Those words reminded him to keep an open mind. And that helped him make money.
In the markets, everyone knows the same things. We all look at the same data. We all watch the same news and read the same articles.
In other words, it’s easy to know what everyone knows. And knowing that is really knowing nothing. You simply can’t beat the market knowing what everyone else knows.
The problem is that market price reflects what everyone knows. The key to beating the markets is to get ahead of the crowd.
Take a look at the article I wrote this week as example of the affects of volatility on the market.
What Everyone Knows About Volatility
Many traders follow volatility. Of course, they all follow the same indicators. They all know the same things about volatility.
Volatility is a widely followed indicator. In a way, it captures the emotion of traders. When traders are calm, prices tend to move up slowly. Relative calm leads to low volatility.
When traders get nervous, volatility tends to rise as prices fall. The more prices fall, the more volatile the price action becomes. This is the reason volatility indicators are sometimes referred to as fear indexes.
In the current market, volatility seems to be falling. It started rising at the end of last year. We have seen a couple of small pullbacks since the start of the year. That’s consistent with higher volatility. But volatility fell in recent days. This led to increased bullishness.
The chart below shows the recent changes in volatility. Dashed lines highlight previous tops in volatility.
Peaks in volatility occurred before price gains. This chart reflects what everyone knows about volatility. Since knowing what everyone knows is to know nothing, this chart tells us nothing. The next chart shows a different view of volatility.
What No One Knows About Volatility
At the bottom of the chart is the momentum of volatility. It’s completing a crossover from bullish to bearish territory. Previous crossovers generally resulted in weak market returns.
In the charts, volatility is measured with an indicator known as the average true range (ATR). This indicator measures the average amount of price movement over the past month. Higher values of ATR show higher volatility.
The second chart measures the momentum of ATR with the MACD indicator. Technical analysts believe that momentum changes direction before trends reverse. While momentum indicators are usually applied to prices, the same idea can be applied to any data.
Red boxes show periods when the MACD of volatility was bearish. It’s not a perfect indicator. No indicator is. But it is useful and identified significant declines in many cases.
Looking at the momentum of market volatility provides information that isn’t available to everyone. It’s an example of going beyond what everyone knows. Right now, the indicator offers a warning.
Before going, I want to let you know that a French philosopher said, “to know what everyone knows is to know nothing.” It was Remy de Gourmont. I doubt de Gourmont was talking about the stock market, but his words could be a profitable philosophy.
Editor, Peak Velocity Trader
After spending nearly 20 years developing pattern recognition software for the United States Air Force, I retired from my military career in 2005. My plan was to utilize the same pattern recognition principals I used in the military and apply them to the largest and most lucrative market in the world: the stock market.