Does an increase in volatility indicate a market top? This
historical look offers some insights.
Back in 1994, it was exciting for
traders watching the Standard &
Poor’s 500 index to get a true
range day of four full points or
better. These days, that small a
daily range is rare; instead, we
are becoming accustomed to true
range days that are 10 and 15 full
points. Is today’s volatility unusually
high by historical standards?
And more important, can high volatility be used to
predict major market turns?
I wanted to look at data going back to the crash of 1929. I
chose the Dow Jones Industrial Average (DJIA), as imperfect
as it is, as my market proxy. The problem with the DJIA is that
its components have changed so radically since then that it
doesn’t really represent the industrial sector anymore.
In addition, the DJIA may be a poor proxy for the broad
market today, because momentum and index-driven funds
trade DJIA stocks. Further, the large-capitalization stocks
may be more volatile than the rest of the market. In fact, the
DJIA can move in directions different from the broad market as
measured by indices such as the NASDAQ or the Russell 2000.
However, the capitalization of the DJIA is a substantial
portion of the overall market. That, coupled with the longev-ity
of the DJIA history, makes it one of the few indices we can
use to perform long-term analysis.