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11/11/2014: The implications of falling volatility on European markets


On a quiet day, with a dearth of economic news and the US on Veterans Day public holiday, the European markets have been devoid of any direction and a distinct lack of intent. To be fair, perhaps we have been spoilt for volatility in recent weeks as days such as today feel as though they are incredibly rare.

However, this might become increasingly commonplace as volatility is now on the wane once more. Look at the volatility indices for both the FTSE 100 and the DAX below.

FTSE volatility   11112014

 

DAX volatility   11112014

Since the reversal of the huge increase in volatility that was seen in early October, during which the markets plummeted to key lows, equity markets have become far more orderly, with steady recovery gains. Volatility has subsequently fallen back towards more “normal” levels as investor fears have settled.

Contrarian traders may begin to question the implications of the psychology that could see markets such as the S&P 500 settle into slow and steady gains. This is exactly the sort of situation that investors were met with during September, between earnings seasons and VIX Index of S&P 500 options volatility trading around record lows. This was just before the sharp exogenous shocks were seen that rattled market confidence.

As yet there is little to suggest that a level of “complacency” has entered the market, however consistently falling and low volatility can be a warning signal. This is why intermittent market corrections are seen as healthy in the development of a bull market. They keep traders honest and keep the complacency from creeping in.Looking at the S&P 500, with the RSI up at 68 again, it is getting to the stage where a correction is needed again. European markets are not in position quite yet, with RSI at 60 the FTSE 100 and at 58 on the DAX, but if this slow and steady recovery continues, and volatility continues to fall, the need for a healthy correction will rise.


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