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Comparing Daily Range Volatility in SP500 and Dow Jones

Wed, Feb 22, 11:31 AM ET, by Corey Rosenbloom

While there are plenty of methods to assess the volatility environment of a market, one of the simplest tactics is to measure the daily range.

Let’s take a look at the pure daily range of the S&P 500 and Dow Jones index through major up and down periods over the last few years.

Here’s the S&P 500:

Click for full-size image.

The custom indicator at the bottom subtracts the low of the day from the high of the day, which gives us the point spread or range of the day.

For example, if the S&P 500 opened at 1,000 which was the low of the session and formed a high of the day at 1,010, then the daily range would be 10 points.

This time of simple calculation does not take into account the open or close (unless those values happened to be the absolute high or low of the session) and does not count any gaps in its calculation.

What can we learn from a chart like this and why is it important?

First, volatility – or range – tends to cycle from periods of high volatility to low volatility.

Stated differently, periods of low volatility often break into periods of high volatility, and vice-versa.

Second, there’s a strong correlation between periods of high volatility (large daily range) and declines in the market – such as the periods I’ve highlighted above.

The opposite is also true – periods of low volatility tend to be correlated with steady or lengthy rises in the market.

There’s something to be said about that – we tend to be confident and calm during periods of bullish rallies and then panic or get emotional during periods of sharp decline.

This sort of psychology reveals itself in part via the daily range (or other volatility measures).

Third, we can see periods during a “market collapse” where volatility increases very sharply, and then steadily declines as price forms a base and begins to rally.

The two recent examples are the “Flash Crash” of May 2010 and the “August Collapse” of 2011.

Both cases began with an initial price plunge (surge in volatility) and then ended with a basing or consolidation period as prices stabilized before resuming the dominant uptrends.

For reference, over the last three years, a daily range of 30 points in the S&P 500 has been the dividing line between abnormally high volatility in the context of a market decline and otherwise stable rising trends.

During the recent rise period in 2012, the daily S&P 500 range has been under 20 points per day, with some days registering under 10 points.

That clues us in that a cycle of high volatility could be developing in the future.

The picture is similar – and of course point values different – in the Dow Jones Index:

We see the same initial spikes in Daily Range which then give way to reduced range as price stabilizes after an initial surge in volatility (and ‘collapse’ in price).

The level that divides high volatility daily range from low volatility range in the Dow seems to be around 200 to 300 points.

During 2012, the Dow has consistently registered near or under 100 points per day for a high to low range.

Take a further look at these charts and the cycles of volatility in terms of the index daily range values and feel free to share additional insights you find.

Corey Rosenbloom, CMT
Afraid to Trade.com

Follow Corey on Twitter: http://twitter.com/afraidtotrade

Corey's new book The Complete Trading Course (Wiley Finance) is now available!

blog.afraidtotrade.com


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