Volatile Volatility

As the summer draws to a close traders will be trying to reflect on what has been dramatic two months of market activity. Autumn is traditionally the most volatile time for the markets, with trade higher than in the slow summer months, so it could prove to be a serious roller coaster ride for all traders.

The period running up to August was both calm and predictable. The markets found a comfortable range within which to trade and since April the FTSE stood at a constant 200-300 point range. Many, including myself, expected a quiet summer – albeit with a small print disclaimer, ‘Assuming no crisis rears its head’.

It turns out it was fortunate that disclaimer was in place. At the beginning of August a crisis hit when the United States lost their AAA credit rating for the first time in their history. This served as confirmation that the sovereign debt crisis was not just confined to the weakest members of the Eurozone, but also to the mighty US.

This was the catalyst for a sharp revaluing of the global equity markets, with most developed world indices corrected by over 10%. The following six weeks offered little respite, with the daily ranges enough to catch out even the most sophisticated traders. As we know professional traders thrive on volatility and the movement of the volatility index, the VIX, which shifted from 15 in July to 47 in mid-August, would suggest a bumper crop for the astute speculator. However this was far from the case.

When markets plummet and continue to feel weak, professional traders normally short the market, looking for a continuation of the move. However it was soon apparent that one minute the equity markets would look extremely weak and the next minute, and I mean ‘minute’, the markets would reverse and return a great deal stronger. These choppy conditions are not favoured by the professional traders and many struggled to capitalise on what would normally be an early Christmas present of volatility. These conditions were certainly not helped by the relative illiquidity of the summer markets, but they were accentuated by the underlying sense of uncertainty of what lay ahead.

However, commodity bulls were able to make the most of this unease with the price or Gold jumping to just shy of $1950/oz and many analysts suggested it could fly higher still to $2500/oz. These severe daily ranges that rocked the equity markets have subsided slightly, and this has seen gold priced down to $1600/ounce. The slight reduction in volatility is no bad thing for both the pro traders and the retail investors, who may decide that now is the time to re-enter the market, albeit in a more controlled fashion.

Nobody likes the Euro, especially the professional traders. While eyes had been firmly focused on the equity and commodity markets for most of the summer, the EUR/USD spot contract had been relatively neglected with limited activity, confined to a 1.40-1.47 range since May; however in September the 1.40 level was breached and the market has not looked back since, with lows of 1.3350 within a couple of weeks of the break. Any rally in this contract seems to be viewed an opportunity to short again. Work on the street is that 1.38 is a major resistance level and pro traders are likely to generate short positions there, although it appears that the shorting on the current up move has already begun…

With a Greek default seemingly imminent, the most volatile markets may yet materialise, generating opportunities where the risk rewards may be unpalatable to most traders, professionals and retail investors alike.