Measures of volatility during this selloff have been uncharacteristically low. Some analysts interpret this to mean traders anticipate higher prices ahead.
They’re confused. The problem is that the financial lexicon has been corrupted by the tendency to use “volatility” as a euphemism for declining prices. Afraid to say it right out, when they suspect lower prices lie ahead, many pundits will say things like “… expect more volatility …”. Maybe they think it makes them sound smart. But it can backfire. Fuzzy terminology has backed up into fuzzy thinking. While it is true that there is a statistical correlation between volatility and general price direction, it’s by no means a rule. Prices can decline just as smoothly as they can rise smoothly. Volatility is not the same as inverse trend.
In recent days the decline in stock prices has been remarkably smooth. This is a counterpoint to the smooth rise in prices we’ve seen before, notably for most of last year. That rise had remarkable staying power, and there’s no reason relatively low volatility in the other direction can’t be accompanied by the same. In other words, volatility per se does not determine trend.
The directional trend of prices in any market is what it is. The term volatility refers to the amount of fluctuation – up and down – within this trend. Keep these concepts firmly separate in your mind.
Not everyone fudges this way; many folks do mean volatility when they say volatility. But if someone says they expect a lot of volatility in the next year, how does that help you? Unless you are a “vol” trader, not much. Most of us care more about whether an investment will be higher or lower than whether it’ll jump around a lot. Some even treat volatility as an asset class in its own right. We’re not among them. Sure it’s possible to make money trading volatility, but it’s easy to lose a lot that way too. Some folks lost almost everything in the sudden volatility surge early this year. Getting cute with your investments is a hard way to make money and an easy way to lose it. Unless you’re a trading aficionado or professional money manager you’re best off keeping it simple.