The stock market goes through cycles of volatility. These cycles are referred to as regime change.
Historically, the market spends about 85 percent of the time rising in a bull market with low volatility. The other 15 percent of the time it falls with higher volatility. Volatility is defined as the standard deviation of the historical market returns.
On a side note, it’s interesting to look at where the terms bull and bear market originates. A bull market is a rising market and a bear market is a falling market. Bear markets are defined as drops of at least 20 percent that last for six months or more. A decline of less than 20 percent, but at least 10 percent is known as a “correction.”
The practice of referring to stock market cycles as bull and bear markets goes back to early California history. The old timers would stage bull and bear fights, and bet on the outcome. They would round up a grizzly bear prior to the extinction of the California grizzly and put in a pen with the meanest bull they could find.
The two would fight and the bear would stand on its haunches and strike down at the bull with its claws, while the bull would charge the bear and strike up with its horns. So, bull markets go up and bear markets go down.
When markets are rising, the volatility is typically low and higher when markets are falling. The past volatility of the market can be measured. But the market also looks forward and considers the future volatility, which is known as the implied volatility.
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There is an index for volatility, which is called the “fear index” because it rises when investors are nervous and falls when they are complacent. The volatility index is the VIX. It is calculated by measuring the implied volatility of nearby options on the S&P 500 index.
When investors are worried they will purchase put options for protection, which causes the prices of those options to rise. As the prices of those options rises, the VIX or fear index rises.
Currently, the VIX is very low with a reading just over 11. The lowest it’s been this year is 8.84, and that was back in late July. The VIX spiked to a 96.40 reading in 2008 during the housing crisis.
It’s important to know that volatility cycles are normal, and there will be times when stock prices can move rapidly.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.
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