Saturday, November 14, 2015

Volatility and Trading Ranges: Energy and Commodities

Once again, the busy trading week ends with decisive movement to take into the doldrums of Saturday and Sunday. Investors are left with a particularly bad taste in their mouth after stocks turn bearish on them. Across the globe, we are seeing a systematic loss hit securities that may or may not have been at speculated highs. Let's look at a chart.

Provided by FactSet

Here, we have three of the major national indexes plotted over the past three months, from the correction in August to trading now. Most of the trading that is represented by the graphs is in October, the month with the largest bullish gains so far this year. As can be seen, equity growth during that month surged up to pre-correction heights (except for the Shanghai Composite Index). The S&P 500 reached a new high. in fact, just 0.87% higher than pre-correction levels, and the Euro STOXX 50 capped at just under that point. Even though the Chinese stock market only gained to about 90% of their previous price, they saw the highest gains of 22.35% over the past three months. Investors in that market can attribute the accelerated growth to the tendencies of cyclicality where the largest dips give way to the largest gains in the future. The causes of the losses differed across the three indexes as well. The Shanghai Composite's equities fell after an asset bubble popped and sparked a national sell off. Meanwhile, the S&P 500 and Euro STOXX 50 responded to a recession-like force that crippled manufacturing and industrial growth in the world's exporting nation. Indexes and assessments measuring the performances of these sectors were not only weak in China, but the U.S., Europe, and just about anywhere else as well. We all know this though. This is just about ancient history. Instead, today we're talking about another bearish trend developing this week. The blue line denotes the beginning of this week which featured flat movement at the opening on Monday. For the week, Shanghai Composite losses amounted to -2.18%, Euro STOXX 50 to -1.69%, and S&P 500 losses to -2.67%. The week signaled a technical reversal from a resistance level that had been established last August. Now, equities will begin to bounce down as Dow Industrial futures already traded 75 points lower after Friday's close. On top of that, terrorist attacks on the same day have shaken global stability and will no doubt add to economic uncertainty. The French economy has already experienced some of the possible repercussion of the Parisian terrorist attacks as retailers closed down Friday night and Saturday in order to recovery from the tragedy. European stocks also have a high probability of entering a new trading week on fragile investor confidence that has already seen the start of a bearish trend.

So what of these trends in 2015? I hope it is not just me when I think of how unnecessarily volatile stock market movements have been. The S&P and Dow have been trading in very large ranges. The difference between YTD highs and lows in the DJIA is over 10% of its current level. These changes haven't been gradual either. Many investors will remember days where 100-200 points were shed off of the Dow at a time, and these trends haven't been restricted to U.S. major market indexes. The Shanghai Composite is a good example of a particularly volatile entity this year as it careened into recession, and many sectors heavily affected by the slowdown showed increased volatility as well. These wide trading ranges add towards the uncertainty that contributes to volatility and have become a good indicator in hindsight.



Both from FactSet

The graph and the chart demonstrate the wide ranges of trading in sectors that were most hurt by a worldwide manufacturing slowdown. Commodities and the energy sector experienced the largest gaps with ranges over 20% and 30% compared to average prices. Last year, they were just about 10% less wide. As has been said before, this volatility is attributed to low oil prices that have rallied and fell through the early parts of the year as well as in the summer. Ranges of trading in WTI might even be wider, and they have certainly been a key driver in commodity and energy volatility. Moving to industrials and consumer good sectors, wide ranges can be observed as well. Though not as volatile as the first two sectors, these industries have shown considerable uncertainty when trading under the global slowdown sparked by the popping of a Chinese asset-bubble. Demand from emerging markets that rely on cheap and open access to raw and manufactured goods were damaged by an exit of significant amounts of investor capital. Combined with a stronger dollar, these contracting macroeconomic factors have created a strong bullish presence in these sectors that was particularly evident in quarter three. Large trading gaps may not seem significant in terms of technical trading, but I think they can provide a way to appropriate an ideal price target in trading. The idea of "regressing towards the mean" is quintessential to statistical observations that can be applied to market analysis Taking into account highs and lows in trading as resistance and support levels, one should be able to estimate an intermediate-term price target. This calculation would treat highs and lows as short-term periods of over-buying or over-selling as they are often corrected (just like in August and October). While buying and selling during trends does no good for valuation, instead a proper price is most likely wedged in a tight range in the middle. True valuations may not help technically, but they can assist in fundamental analysis where proper share prices are relevant. These values can found in the average price column and are subject to change as prices change over time. Going into the end of the year, these four sectors will be particularly sensitive to their valuations as companies are reconsidered in periods before and after interest rate hikes as well as the speeding up of the world economy. By those numbers, gains in October may be in danger of falling to bears who are seeking to protect their money from the uncertainty in trends.

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