Navigating the stock market is akin to sailing the unpredictable seas. While sometimes the water is calm, at other times, it can be incredibly tumultuous. Just as every sailor has his trusted weather report and tools, we as investors must rely on data, trends, and patterns to gauge what’s coming our way. Recently, one crucial measure of the stock market’s sentiment has caught our attention: volatility. But are we on the brink of a massive breakout in volatility?
The Current Calm
For starters, implied volatility, which is derived from option prices on the US stock market, is currently presenting a serene picture. Notably, the Bank of America pointed out that it has not been this economical to hedge over a twelve-month period since the 2008 financial crisis. An intriguing observation, no doubt. So, as an astute investor, one naturally wonders: have we entered a permanently low volatility phase, or is this just the lull before an impending storm?
Learning from History
To seek answers, let’s delve into stock market history. I decided to use one of the most comprehensive data series available, tracking the Dow Jones Industrial Average from 1915. That’s a vast wealth of knowledge, spanning over a century! In order to standardize this vast dataset, I made certain adjustments, such as removing the trading data from Saturdays of yesteryears.
To further bring clarity and continuity to the data, I’ve gauged historical volatility, which is rolled and overlapped across a period of 21 trading days (roughly a month). This approach provides a smoothed perspective on volatility over time.
Dow Jones Volatility, Seasonal Pattern, 1915 to 2023
Deciphering Seasonal Volatility
But, with the existing calm, can we expect a surge in volatility soon?
When analyzing the seasonal volatility cycle, some patterns are hard to ignore. A chart spanning from 1915 shows how the 21-day volatility of the Dow Jones typically fares throughout the year. As the data indicates, there is a distinct seasonal trend in volatility.
For instance, from the end of July to early August, a conspicuous summer lull pushes average volatility levels below 14%. But as we transition into autumn, there’s a sharp uptick, culminating in early November at a peak of 18.3%.
Why Investors Shouldn’t Be Complacent
Presently, the low volatility seems to have lulled many into a false sense of security. But this could prove to be a miscalculation. Given the historical trend, we could very well see spikes in volatility extending into November.
The intriguing bit is that many traders, especially in the volatility and options markets, don’t capitalize on this seasonality. But, as an informed investor, you could potentially harness this knowledge, positioning yourself favorably and possibly even outpacing your competitors.
In essence, while the current volatility landscape might seem placid, history and data hint at an impending shift. Although no prediction can be made with absolute certainty, being prepared and understanding seasonality can undoubtedly give you an edge.
Always remember, just as sailors respect the seas’ unpredictable nature, we as investors must always be ready for the stock market’s ever-changing moods. And as the age-old adage goes, “Forewarned is forearmed.”
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