Self Directed Investor Inc
SDI: "Empowering investors with ideas and education"
Symbol Lookup »  

  • Other news: News from PR Newswire
| More

Volatility During Crises

Fri, Dec 21, 10:32 AM ET, by Bill Luby

[The following first appeared in the August 2011 edition of Expiring Monthly: The Option Traders Journal. I thought I would share it because it might help some readers put the current fiscal cliff crisis in historical context.]

The events of the last three weeks are a reminder that financial crises and stock market volatility can appear almost instantaneously and mushroom out of control before some investors even have a chance to ask what is happening. A case in point: on August 3rd investors were breathing a sigh of relief after the United States had finalized an agreement to raise the debt ceiling; at that time, the VIX stood at 23.38, reflecting a relative sense of calm, yet just three days later, the VIX jumped to 48.00 as two new crises displaced the debt ceiling issue.

Spanning the globe from Northern Africa, Japan, Europe and the United States, 2011 has seen no shortage of crises in the first eight months of the year. Given this pervasive crisis atmosphere, it is reasonable for investors to consider how much volatility they should anticipate during a crisis. In this article I will attempt to put crises and volatility in some historical perspective and address a variety of factors that affect the magnitude and duration of volatility during a crisis, drawing upon fundamental, technical and psychological causes.

Volatility in the Twentieth Century

Every generation likes to think that the issues of their time are more daunting and more complex than those faced by prior generations. No doubt investors fall prey to this kind of thinking as well. With a highly interconnected global economy, a news cycle that races around the globe at the speed of light and high-frequency and algorithmic trading systems that have transferred the task of trading from humans to machines, there is a lot to be said for the current batch of concerns. Looking at just the first half of the twentieth century, however, investors had to cope with the Great Depression, two world wars and the dawn of the nuclear age.

Given that the CBOE Volatility Index (VIX) was not launched until 1993, any evaluation of the volatility component of various crises prior to the VIX must rely on measures of historical volatility (HV) rather than implied volatility. As the S&P 500 index on which the VIX is based only dates back to 1957, I have elected to use historical data for the Dow Jones Industrial Average dating back to before the Great Depression. In Figure 1 below, I have collected peak 20-day historical volatility readings for selected crises from 1929 to the present.

Before studying the table, readers may wish to perform a quick exercise by making a mental list of some of the events of the 20th century that constituted immediate or deferred threats to the United States, then compare the magnitude of that threat with the peak historical volatility observed in the Dow Jones Industrial Average. If you are like most historians and investors, after looking at the data you will probably conclude that the magnitude of the crisis and the magnitude of the stock market volatility have at best a very weak correlation.

[source(s): Yahoo]

Any ranking of crises in which the Cuban Missile Crisis and the attack on Pearl Harbor rank in the lower half of the list is certain to raise some eyebrows. Frankly I would have been surprised if even one of these events failed to trigger a historical volatility reading of 25, but seeing that was the case for half the crises on this list certainly provides a fair amount of food for thought.

Volatility in the VIX Era

With the launch of the VIX it became possible not only to evaluate historical volatility, but implied volatility as well. With only 18 years of data to draw upon, there is a limited universe of crises to examine, so in the table in Figures 2 below, I have highlighted the seven crises in the VIX era in which intraday volatility has reached at least 48. Additionally, I have included five other crises with smaller VIX spikes for comparison purposes.

[source(s): CBOE, Yahoo]

[Some brief explanatory notes will probably make the data easier to interpret. First, the crises are ranked by maximum VIX value, with the maximum historical volatility in an adjacent column for an easy comparison. The column immediately to the right of the MAX HV data captures the number of days from the peak VIX reading to the maximum 20-day HV reading, with negative numbers (LTCM and Y2K) indicating that HV peaked before the VIX did. The VIX vs. HV column calculates the amount in percentage terms that the peak VIX exceeded the peak HV. The VIX>10%10d" column reflects how many days transpired from the first VIX close above its 10-day moving average to the peak VIX reading. The SPX Drawdown column calculates the maximum peak to trough drawdown in the S&P 500 index during the crisis period, not from any pre-crisis peak. The VIX:SPX drawdown ratio calculates the percentage change in the VIX from the SPX crisis high to the SPX crisis low relative the percentage change in the SPX during the same period (of course these are not necessarily the VIX highs and lows during the period.) The SPX low relative to the 200-day moving average is the maximum amount the SPX fell below its 200-day moving average during the crisis. Finally, the last two columns capture the number of consecutive days the VIX closed at or above 30 during the crisis and the number of days the SPX closed at least 4% above or below the previous day's close during the crisis.]

Looking at the VIX era numbers, it is not surprising that the financial crisis of 2008 dominates in many of the categories. Reading across the rows, one can get an interesting cross-section of each crisis in terms of various volatility metrics, but I think some of the more interesting analysis comes from examining the columns, where we can learn something not just about the nature of the crises, but also about volatility as well. One important caveat is that the limited number of data points does not allow for this to be a statistically valid sample, but that does not preclude the possibility of drawing some potentially valuable and actionable conclusions.

Looking at the peak VIX reading relative to the peak HV reading I note that in all instances the VIX was ultimately higher than the maximum 20-day historical volatility reading. In the five lesser crises, the VIX was generally 50-80% higher than peak HV. In the seven major crises, not surprisingly HV did approach the VIX in several instances, but in the case of the 9/11 attack and the 2010 European sovereign debt crisis the VIX readings grossly overestimated future realized volatility.

One of my hypotheses about the time between the first VIX close above its 10-day moving average and the ultimate maximum VIX reading was that the longer the period between the initial VIX breakout and the maximum VIX, the higher the VIX spike would be. In this case the Long-Term Capital Management (LTCM) and 2008 crises support the hypothesis, but the data is spotty elsewhere. The current European debt crisis, Asian Currency Crisis of 1997 and 9/11 attack all reflect a very rapid escalation of the VIX to its crisis high. In the case of the May 2010 'Flash Crash' and the Fukushima Nuclear Meltdown, the maximum VIX reading happened just one day after the initial VIX breakout. As many traders use the level of the VIX relative to its 10-day moving averages as a trading trigger, the data in this column could be of assistance to those looking to fine-tune entries or better understand the time component of the risk management equation.

Turing to the SPX drawdown data, the Asian Currency Crisis stands out as one instance where the VIX spike seems in retrospect to be out of proportion to the SPX peak to trough drawdown during the crisis. On the other side of the ledger, the drawdown during the Dotcom Crash appears to be consistent with a much higher VIX reading. Here the fact that it took some 2 ½ years for stocks to find a bottom meant that when the market finally bottomed, investors were somewhat desensitized and some of the fear and panic had already left the market, which is similar to what happened at the time of the March 2009 bottom. Note that the median VIX:SPX drawdown ratio for all twelve crises is 10.0, which is about 2 ½ times the movement in the VIX that one would expect during more normal market conditions.

The data for the SPX Low vs. 200-day Moving Average is similar to that of the SPX drawdown. For the most part, any drawdown of 10% or more is likely to take the index below its 200-day moving average. In the seven major crises profiled above, all but the Asian Currency Crisis dragged the index below its 200-day moving average; on the other hand, in all but one of the lesser crises the SPX never dropped below its 200-day moving average. Based on this data at least, one might be inclined to include the 200-day moving average breach as one aspect which helps to differentiate between major and minor crises.

As I see it, the last two columns - consecutive days of VIX closes over 30 and number of days in which the SPX has a 4% move - are central to the essence of the crisis volatility equation. Since the dawn of the VIX, the SPX has experienced a 2% move in about 80% of its calendar years, the VIX has spiked over 30 about 60% of the years, and the SPX has seen at least one 4% move in about 40% of those years. Those 4% moves are rare enough so that they almost always occur in the context of some sort of major crisis. In fact, one could argue that a 4% move in the SPX is a necessary condition for a financial crisis and/or a significant volatility event.

Fundamental, Technical and Psychological Factors in Crisis Volatility

Crises have many different causes. In the pre-VIX era, we saw a mix of geopolitical crises and stock market crashes, where the driving forces were largely fundamental ones. During the VIX era, I would argue that technical and psychological factors become increasingly important. The rise of quantitative trading has given birth to algorithmic trading, high-frequency trading and related approaches which place more emphasis on technical data than fundamental data. At the same time, retail investing has been revolutionized by a new class of online traders and the concomitant explosion in self-directed traders. This increased activity at the retail level has added a new layer of psychology to the market.

In terms of fundamental factors, one could easily argue that the top nine VIX spikes from the list of VIX era crises all arise from just two meta-crises, whose causes and imperfect resolution has created an interconnectedness in which subsequent crises are to a large extent just downstream manifestations of the ripple effect of the original crisis.

The first example of the meta-crisis effect was the 1997 Asian Currency Crisis, which migrated to Russia in the form of the 1998 Russian Ruble Crisis, which played a major role in the collapse of Long-Term Capital Management.

The second example of meta-crisis ripples begins with the Dotcom Crash and the efforts of Alan Greenspan to stimulate the economy with ultra-low interest rates. From here it is easy to draw a direct line of causation to the housing bubble, the collapse of Bear Stearns, the 2008 Financial Crisis and the recurring European Sovereign Debt Crisis. In each case, the remedial action for one crisis helped to sow the seeds for the next crisis.

In addition to the fundamental interconnectedness of these recent crises, it is also worth noting that the lower volatility crises were largely point or one-time-only events. There was, for instance, only one Hurricane Katrina, one turn of the clock for Y2K and one earthquake plus tsunami in Japan. As a result, the volatility associated with these events was compressed in time and accordingly the contagion potential was limited. By contrast, the major volatility events are more accurately thought of as systemic threats that ebbed and flowed over the course of an extended period, typically with multiple volatility spikes. In the same vein, the attempted resolution of these events generally included a complex government policy cocktail, whose effects were gradual and of largely indeterminate effectiveness.

Apart from the fundamental thread running through these crises, I also believe there is a psychological thread that sometimes spans multiple crises. Specifically, I am referring to the shadow that one crisis casts on future crises that follow it closely in time. I call this phenomenon 'disaster imprinting' and psychologists characterize something similar as availability bias. Simply stated, disaster imprinting refers to a phenomenon in which the threats of financial and psychological disaster are so severe that they leave a permanent or semi-permanent scar in one's psyche. Another way to describe disaster imprinting might be to liken it to a low-level financial post-traumatic stress disorder. Following the 2008 Financial Crisis, most investors were prone to overestimating future risk, which is why the VIX was consistently much higher than realized volatility in 2009 and 2010.

While it is impossible to prove, my sense is that if the events of 2008 were not imprinted in the minds of investors, the current crisis atmosphere might be characterized by a much lower degree of volatility and anxiety.


As this goes to press, the current volatility storm is drawing energy from concerns about the European Sovereign Debt Crisis as well as fears of a slowdown in global economic activity. The rise in volatility has coincided with a swift and violent selloff in stocks that has seen six days in which the S&P 500 index has moved at least 4% either up or down - a rate that is unprecedented outside of the 2008 Financial Crisis.

Ultimately, the severity of a volatility storm is a function of both the magnitude and the duration of the crisis, as well as the risk of contagion to other geographies, sectors and institutions. Act I of the European Sovereign Debt Crisis, in which Greece played the starring role, can trace its origins back to December 2009. In the intervening period, it has spread across Europe and has sent shockwaves across the globe.

By historical standards the volatility aspect of the current crisis is more severe than at any time during World War II, the Cuban Missile Crisis and just about any crisis other than the Great Depression, Black Monday of 1987 and the 2008 Financial Crisis.

In the data and commentary above, I have attempted to establish some historical context for volatility during various crises extending back to 1929 and in the process give investors some metrics for evaluating current and future volatility spikes. In addition, it is my hope that concepts such as meta-crises and disaster imprinting can help to bolster the interpretive framework for investors who are seeking a deeper understanding of volatility storms and the crises from which they arise.

Related posts:

Disclosure(s): none

SDI Glossary: "CBOE" Definition
SDI Glossary: "Debt" Definition
SDI Glossary: "Option" Definition
SDI Glossary: "Short" Definition
SDI Glossary: "VIX" Definition
SDI Glossary: "Volatility Index " Definition
This Article's Word Cloud:   Crisis   European   Volatility   about   above   average   below   case   column   crises   crisis   current   data   days   disaster   drawdown   during   events   financial   first   from   fundamental   have   historical   index   investors   just   least   major   market   maximum   more   moving   number   only   peak   period   reading   some   than   that   these   this   time   trading   volatility   were   which   with   would

| More

Either a Bounce or Another Collapse Plan for Apple AAPL
Tue, May 3, 11:31 AM ET, by Corey Rosenbloom

Cutting to the point, Apple shares (AAPL) either support-bounce and rally up away from the ...

Crude Oil Collapses to Lower Targets with Stocks May 3
Tue, May 3, 11:11 AM ET, by Corey Rosenbloom

Though rallying to the $47.00 per barrel short-term target, Crude Oil reversed lower with a ...

May 3 Gap into Fibonacci Level Emini Update for the Day
Tue, May 3, 9:51 AM ET, by Corey Rosenbloom

You may be surprised at how well our short-term Fibonacci Planning Grid is working to ...

VMAX and VMIN Poised to Be Most Important VIX ETP Launch in Years
Tue, May 3, 8:11 AM ET, by Bill Luby

REX Shares is launching two new VIX exchange-traded products on Tuesday in what is likely ...

May 2 Emini Fibonacci Level Planning Update
Mon, May 2, 12:21 PM ET, by Corey Rosenbloom

You may be surprised at how well our short-term Fibonacci Planning Grid is working to ...

The April 29 Gold Triangle Breakout Update
Fri, Apr 29, 2:41 PM ET, by Corey Rosenbloom

If you’re just watching stocks, you may be missing this powerful Triangle Breakout surge in ...

April 29 Collapsing to Support Emini Level Update and Plan
Fri, Apr 29, 1:41 PM ET, by Corey Rosenbloom

After a rally back to the highs on the post-Fed announcement, sellers struck violently, collapsing ...

Rounded Arc Pattern Update and Stock Scan April 28
Thu, Apr 28, 3:11 PM ET, by Corey Rosenbloom

As April rushes to an end, let’s take a look at our current levels, today’s ...

NASDAQ Battles the 200 Day SMA Level Update
Wed, Apr 27, 1:21 PM ET, by Corey Rosenbloom

The tech-heavy NASDAQ Index is weaker than the S&P 500 at the moment due to ...

April 27 Fed Day Emini Range Trading Level Update
Wed, Apr 27, 1:11 PM ET, by Corey Rosenbloom

The @ES build a key short-term trading range based on new Fibonacci Retracement levels. With ...

Breaking Range Market Update and Stock Scan April 26
Tue, Apr 26, 3:21 PM ET, by Corey Rosenbloom

We’re seeing a bullish reversal swing laboriously developing in the S&P 500. Will it hold? ...

April 25 Fibonacci Level Update and Pullback Plan for Eminis
Mon, Apr 25, 12:51 PM ET, by Corey Rosenbloom

We’re seeing the logical and expected pullback (retracement) continue to known target levels today. Here’s ...

Big Intraday Swings in Gold and the US Dollar April 22
Fri, Apr 22, 2:31 PM ET, by Corey Rosenbloom

Have you seen the big swings in Gold and the US Dollar? If you’re trading ...

April 22 Pullback Continues New Emini Level Updates
Fri, Apr 22, 1:23 PM ET, by Corey Rosenbloom

Today logically continued the pullback began from the 2,100 level. We’re now at our initial ...

April 21 Pullback or Reversal Emini Target Level Plan Update
Thu, Apr 21, 12:11 PM ET, by Corey Rosenbloom

Today gives us another shallow (so far) pullback fro the highs toward our initial intraday ...

Short Squeeze Continues Market Update and Stock Scan April 20
Wed, Apr 20, 2:51 PM ET, by Corey Rosenbloom

The pattern aggressive dip-buying continued as bears once again lost money via an extended short-squeeze. ...

The Oops Gap Down in Netflix NFLX
Tue, Apr 19, 11:21 AM ET, by Corey Rosenbloom

Despite better than expected earnings per share and revenue, Netflix (NFLX) stock collapsed overnight into ...

Bullish Domination Emini Level and Trading Update April 19
Tue, Apr 19, 11:11 AM ET, by Corey Rosenbloom

The Intervention Pattern Continues with additional upside price action on a gap-up this morning. Like ...

April 18 Intervention Bullish Break Market Update and Stock Scan
Mon, Apr 18, 3:21 PM ET, by Corey Rosenbloom

Buyers rushed in to halt a down-gap and sell-off this morning, resulting in a strong ...

Intervention Short Squeezes and Emini Level Update April 18
Mon, Apr 18, 12:31 PM ET, by Corey Rosenbloom

Let’s look very closely at a recent blatant pattern of intervention during the current market ...

Pulling Back from the Highs Emini Update April 15
Fri, Apr 15, 12:21 PM ET, by Corey Rosenbloom

Finally, we’re seeing a pullback from resistance. How far will the market retrace and what ...

April 14 Reversal Swing Looming Market Update and Scan
Thu, Apr 14, 2:41 PM ET, by Corey Rosenbloom

We’re reaching the breaking point for our extended rally. Internals aren’t keeping pace with price, ...

Defying Gravity Emini Breakout Level Update April 14
Thu, Apr 14, 12:31 PM ET, by Corey Rosenbloom

Like Elphaba in Wicked, the US Stock Market continues to defy gravity with a breakout ...

April 13 Bullish Breakout Market Update and Stock Scan
Wed, Apr 13, 4:21 PM ET, by Corey Rosenbloom

Breakout! Bulls everywhere! New Highs! No bearishness in sight! That’s not quite true at all, ...

Stepping Inside Breakout Breadth April 13
Wed, Apr 13, 2:31 PM ET, by Corey Rosenbloom

The S&P 500 (stock market) broke out of a range to new swing highs today. ...

A Surprise Breakout Emini New Level Planning April 13
Wed, Apr 13, 12:41 PM ET, by Corey Rosenbloom

Breakout!! However, will the breakout hold and will price continue powering higher? Here’s today’s updated ...

April 12 Support Bounce Range Market Update and Scan
Tue, Apr 12, 2:11 PM ET, by Corey Rosenbloom

The Range Continues with a big stock market bounce this morning. Let’s update our levels ...

Preparing for a Breakout Trade in Netflix NFLX
Tue, Apr 12, 12:11 PM ET, by Corey Rosenbloom

Netflix (NFLX) shares are likely about to break free of a compression range, giving us ...

April 12 Morning Gap Emini Level Update and Plan
Tue, Apr 12, 9:41 AM ET, by Corey Rosenbloom

As we gap up away from our key support pivot, what levels are in play ...

Planning the Next Market Swing from Advance Decline Breadth
Mon, Apr 11, 4:31 PM ET, by Corey Rosenbloom

What message is Breadth sending us about the next likely swing for the stock market? ...

Big Intermarket Moves Today in Gold Oil and US Dollar
Mon, Apr 11, 1:41 PM ET, by Corey Rosenbloom

While the US Stock Market is slightly higher, we’re seeing big intraday breakout moves occur ...

April 11 Repeat Day Emini Expanded Level Update
Mon, Apr 11, 12:11 PM ET, by Corey Rosenbloom

Does this look familiar? It should – today’s gap up into resistance and the sell-off ...

Volatile Gappy Market Update and Stock Scan April 8
Fri, Apr 8, 3:41 PM ET, by Corey Rosenbloom

The volatility and gaps continue for us short-term traders in the market. Let’s update our ...

April 8 Emini Intraday Trading Range Level Update
Fri, Apr 8, 12:21 PM ET, by Corey Rosenbloom

We’re seeing higher volatility, sequential Trend Days, and larger than normal gaps recently. This is ...

April 7 Collapse Market Update and Big Stock Scan
Thu, Apr 7, 3:31 PM ET, by Corey Rosenbloom

Yesterday’s bullish action was erased and exceeded with today’s bearish activity. Let’s update our levels ...

Down and Away We Break from Emini Range April 7
Thu, Apr 7, 2:41 PM ET, by Corey Rosenbloom

That didn’t take long. We’ve highlighted the Fibonacci Grid and sideways trading range levels for ...

April 6 Emini Trade Level Planning for the Morning
Wed, Apr 6, 12:31 PM ET, by Corey Rosenbloom

Our Fibonacci Grid was effective in planning yesterday’s trades within the range. Just now, price ...

The Big Repeat Pattern to Plan the Next Swing April 5
Tue, Apr 5, 12:11 PM ET, by Corey Rosenbloom

What can late 2015 tell us about early 2016? A lot, if the larger price ...

Morning Trading Level Planning for eMinis ES April 5
Tue, Apr 5, 11:11 AM ET, by Corey Rosenbloom

What levels are we trading this morning with the gap and volatility in the @ES ...

My Favorite Five Stocks eBook for You
Mon, Apr 4, 5:41 PM ET, by Corey Rosenbloom

I just published my 5 favorite stock setups for right now. Plus, I show you ...

April 4 Reversal Update and Bearish Stock Scan
Mon, Apr 4, 4:11 PM ET, by Corey Rosenbloom

A logical pullback (retracement) took price back to a key intraday support level. What’s the ...

A Trade and Target Levels in Rising Facebook FB
Mon, Apr 4, 12:31 PM ET, by Corey Rosenbloom

Facebook (FB) continues its strong bullish uptrend, but we’re planning a short-term trading opportunity on ...

April 1 Big Reversal Update and Stock Scan
Fri, Apr 1, 2:51 PM ET, by Corey Rosenbloom

Today has been a heavy economic news day and the market is responding with higher ...

Bullish Surge Continues Update and Stock Scan March 30
Wed, Mar 30, 2:31 PM ET, by Corey Rosenbloom

Stocks surged after Janet Yellen reassured markets yesterday that rate hikes will be extremely gradual ...

Watching the VIX Springboard Level this Week
Tue, Mar 29, 11:51 AM ET, by Corey Rosenbloom

What’s the “VIX Springboard Level” and why should we be watching it this week? Simple ...

Thursday Webinar: How to Determine if Today Will be a Trend or Range Day
Tue, Mar 29, 11:41 AM ET, by Corey Rosenbloom

I’m excited to present a featured expert webinar with TraderKingdom entitled: “How to Determine if ...

Simple SPX Planning Levels to Start the Week March 28
Mon, Mar 28, 12:31 PM ET, by Corey Rosenbloom

As we start the new week of March 28, 2016, what simple planning levels are ...

Riveting Range Market Update and Stock Scan March 24
Thu, Mar 24, 2:51 PM ET, by Corey Rosenbloom

The expected pullback (retracement) continued today with a gap-down toward our 2,025 target. Let’s update ...

The Bearish Rising Wedge Lesson from Virgin America VA
Wed, Mar 23, 12:21 PM ET, by Corey Rosenbloom

What lesson does Virgin America (VA) teach us about the popular “Bearish Rising Wedge” pattern? ...

The Ross Wedge Pattern ROST March 23
Wed, Mar 23, 11:51 AM ET, by Corey Rosenbloom

Ross Stores (ROST) is forming a Rising Wedge worthy of our consideration. Let’s note how ...

  More articles:  1 2 3 4 5 6 7 next »


Volatility During Crises | Self Directed Investor | Copyright © 2008 - 2016, All Rights Reserved

Any ideas and opinions presented in Self Directed Investor content are for informational and educational purposes only, and do not reflect the opinions of BNK Invest, Inc. or any of its affiliates, subsidiaries or partners. In no way should any content contained herein be interpreted to represent trading or investment advice. None of the information contained herein constitutes a recommendation that any particular security, portfolio, transaction, or investment strategy is suitable for any specific person. All site visitors agree that under no circumstances will BNK Invest, Inc,. its subsidiaries, partners, officers, employees, affiliates, or agents be held liable for any loss or damage caused by your reliance on information obtained. Read Full Disclaimer.

SDI is associated with: -- a subscription-based online social networking forum of serious individual investors. | -- videos appearing on SDI are produced by Market News Video. | -- stock quote content appearing on SDI is at least 20 minutes delayed and is powered by Ticker Technologies. | -- Edited by Scott V. Nystrom, PhD, Gold Stock Strategist provides analysis on gold mining companies.