Don Fishback’s Market Update

Last Thursday and Friday, the stock market continued to fall after a devastating Tuesday and Wednesday.  That pushed the Dow’s losing streak to 7 straight down days.

At the same time, during Thursday’s and Friday’s negative sessions, the VIX dropped unexpectedly.  That prompted a few calls and emails wondering why VIX fell as the market declined.

There are three reasons:

One reason has to do with the calendar.  In particular, at the close on Friday volatility of the U.S. market essentially dropped to zero for a few days.  That’s because the market closed for the long holiday weekend.

Another reason has to do with the definition of volatility.  It’s the standard deviation of an asset’s returns.  If the returns are persistently negative, the standard deviation goes toward zero.  The statistical/historical volatility of something that moves consistently up or consistently down is low.  The fact that the stock market had seven straight losing sessions probably had a negative influence on implied volatility as well.

But those two reasons are mere decoration.  The main reason VIX dropped while the market continued lower was due to the speed of the decline.  The market may have moved lower on Thursday and Friday.  But it moved lower at a slower speed on those days than it did on Tuesday and Wednesday.

In fact, even though Thursday and Friday were down days, they were some of the smallest declines we’ve seen since the end of April.

I’ve said this before and I’ll say it again.  Volatility isn’t just about magnitude.  It’s magnitude over time.  With respect to volatility, it’s not enough to know that a 20% move occurred.  Because there’s a big difference if that 20% move takes a week, a year, or a decade.

As an aside, many of you know that I don’t consider volatility as the prime factor in making a trading decision.  That’s because volatlity assumes things that just aren’t represented in the real world.  For instance, the aforementioned concept where a big move that is consistent in one direction leads to low statistical volatility.]

– Don