Volatility free August may just be the “eye of the storm”…

Traders and investors packed their luggage during August, stuffed no doubt with their notebooks (‘e’ variety!) and iPads inside, just in case things turned pear shaped again for global markets as they did last year. Traditionally being a low volatility month, August was a serious headache for investors in 2011. Luckily, this year things were much more peaceful and the month was in fact the fourth least volatile FTSE 100 month for the last twenty years.

Last year was tough for investors as they had to deal with a Japanese tsunami almost ending in a nuclear disaster; a huge political crisis in the MENA region that put pressure on oil; a debt ceiling crisis in US that cost the country the stellar AAA rating; and a deteriorating European sovereign debt story that put Greece in a technical default and led to yields on sovereign debt for other Eurozone countries to hit (then) historical highs. August was an awful month, not only because there were massive drops in equities but also because there was so much volatility in a month when many were just trying to peacefully have some rest.

To measure volatility, I like to use an adaptation of a technical measure – True Range % (TR%). The true range (TR) is a simple measure that gives an idea of how many points a market trades per day, or per period. It roughly estimates the interval between the low and the high for any given period. As the FTSE has changed much over the last twenty years I calculate the true range for each period and then use it as a percentage of the opening price to erase the effect of the growing FTSE number. That gives us the TR%.

If you look at the FTSE 100 chart below depicting TR% for the last twenty years, you can see a peak in August 2011, when the TR% hit 19.3%, with the FTSE trading in a range of 1,122 points – too much for many traders although likely manna from heaven for the most nimble spreadbettors. It was the most volatile August of the last twenty years.

20 Year True Range chart

Contrasting with last year figures, this year’s August was one of the least volatile, in fact the least volatile August for six years with the blue chip index rising 1.4% during the period.

The main reason for the “peaceful wind” hitting both sides of the Atlantic was the co-ordination between central banks – the ECB, FED and the BOE who all avoided engaging in extra monetary easing at their pre-summer meetings but, more importantly, succeeded in tantalising the market with expectations for more QE in September. With economic data in recent weeks being relatively muted, investors now anticipate action from both Bernanke and Draghi.

The peace of August however may just be the “eye of the storm” as market participants return this month – at the end of the day, participants make a market. If central bankers fail to deliver what investors want, equities could suffer significantly.

Editor & Filipe R Costa