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Tuesday, December 11, 2012

Historical volatility implosion

The volatility in the market has been absolutely crushed the last few weeks.  Check this chart out.  The 14 day historical volatility is in the bottom pane.  The green line is at the recent peak and the red line is at the current low reading.

The other two times this year the volatility got this low in SPX we were well off the lows.  Price was also well above the 50 SMA.  That is normal for a low volatility situation.  In searching the memory banks for times when we might have had such low volatility and still be at or below the 50 SMA I came up empty.  I decided it might be better to check out the chart and see what I could find.  Apparently this is a very rare combination.  I had to go all the way back to 1994 to find an instance.  It happened fairly similar two different times that year.

Here is the chart.

In the first instance in 1994, SPX was still clearly below the 50 SMA and rolled over.  In late 1994, it closed above the 50 SMA by three points.  It then closed fractionally back below the 50 for two days, then took off to the upside. The green line in the volatility pane is not present in this chart because the peaks in this time period were well below the current peak.  In 1991 and 1996 there were similar peaks to our recent peak.  It was over four years in between those peaks.  Talk about a calm market.  That is it.  In the other similar situations, SPX had clearly broken above the 50 before the volatility imploded.

In 1994 we had a mini crash and a big rally from similar setups.  Will we get another big move from here one way or the other?


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