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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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At Hantec Markets Ltd we provide an execution only service. Any opinions expressed by analyst Richard Perry should not be construed as investment advice or an investment recommendation. This report does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. Forex and CFDs are leveraged products which can result in losses greater than your initial deposit. Therefore you should only speculate with money that you can afford to lose. Please ensure you fully understand the risks involved, seeking independent advice if necessary prior to entering into such transactions.