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What is Normal Stock Market Volatility

Posted by David Bean on

It is important to use data and facts to develop and trade your strategies. Volatility can be a larger factor in the success of a trading strategy than the actual direction of the market. There has been a great deal of disbelief in the current market volatility. Jack Bogle, founder of the index fund giant Vanguard Group, said that, "he’s never seen volatility like this in his 66-year career".

Many investors see this volatility as anomaly and continue to believe that volatility should drop and the market should return to new highs. I would make the case that this volatility is actually more normal than what we have seen in the last 15 years, since 2003.

Since 2003, monetary policy from federal reserve chairman, Alan Greenspan, Ben Bernanke, and Janet Yellen, have been accommodative for investors in the stock market. Jerome Powell has been more hawkish with a focus on the original mandate of the Federal Reserve, which is maximum employment and price stability. Moving the fed funds rate to a more "normal" rate and reducing the fed's balance sheet have been the objective. A more "normal" monetary policy gives us a more normal market environment (pre-2003), including more normal market volatility.

While volatility can be measured in many ways, one of the most basic measurements is to look at the average daily range. In order to be fair, we have to use the average daily range as a percentage of the close. A 1% range for a Dow 1,000 is 10 points, a 1% range for a Dow 10,000 is 100 points, a 1% range for a Dow 100,000 is 1,000 points. At current Dow Jones values a 2% range is about 500 points. 1-2% ranges based on the closing value of the index is a normal value in our study of the Dow Jones.

We use the Dow Jones data from the Tradestation platform going back to 1920. We could use other indexes but the Dow Jones gives us more history. Before 1928, the data is more "spotty".

We see that 1.5% is the value of the average daily range as a percentage of the close from 1920-2018. 1.9% is the average daily range as a percentage of the close from 1980-2002. From 2003-2017, the average daily range as a percentage of the close is 1.2%. From 2010-2017, the average daily range as a percentage of close is 1.0%. In 2017, we reached 0.50% and in 2018, we were back to 1.2%, which is below the long term average of 1.5%. 

In the end, market volatility can be the biggest factor in trading system development. While market direction is important, if you get volatility wrong, your directional analysis may not matter.

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