Investors have had plenty to digest lately – persistent inflation, uncertainty around interest rates, elevated Treasury yields, and ongoing geopolitical risks. Yet volatility has almost completely disappeared from the market.
The CBOE Volatility Index (VIX), often referred to as Wall Street’s fear gauge, fell back below 15 last week. On Friday, it traded as low as 14.1 – its lowest level since December last year.
For some folks, that might sound like a good thing. With the S&P 500 just a fraction below its all-time high, that low VIX makes things seem all rather comfortable.
But this market is too quiet.
The VIX is pricing an unusually benign environment at a time when plenty of risks remain. And as a trader, that creates its own set of challenges…
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Many people assume quiet markets are easier to trade. But the opposite is typically true.
When volatility falls, option premiums usually fall with it. And when the broader market is slowly grinding higher rather than making large moves, there are fewer obvious opportunities to exploit. A fast-moving and volatile market can give traders an edge.
And that’s relevant to the way I trade. As a mean-reversion trader, I’m constantly looking for markets that have moved too far in one direction. That way, I can take advantage when momentum reverses and a stock snaps back the other way.
But you need movement to create those opportunities. When the S&P 500 is slowly grinding higher with a calm VIX, those setups become much harder to find.
And even if a promising setup unfolds, the potential reward might not be adequate for the risk you’re taking on. That’s why I’m less active right now than I usually am.
As traders, our job is not to trade for the sake of trading. We should put our capital to work only when the odds are tipped in our favor.
Market conditions never stay the same forever. And right now feels a bit like the calm before the storm.
I’ve traded through enough different market cycles to know that periods of unusually low volatility eventually give way to periods when volatility picks up. And that often happens when you least expect it.
I expect volatility to pick up as we move into the remainder of the year. There’s no shortage of potential catalysts.
Inflation sits well above the Fed’s 2% target. Interest rates remain uncertain. Treasury yields are elevated. And after the market’s strong run, valuations feel stretched. Any one of these factors could shake the market out of its complacency and trigger a correction.
Most investors don’t look forward to market corrections, but traders have a different take. Corrections can create some of the best trading opportunities for significant profits in a short time.
Stocks start making bigger moves, volatility rises, and option premiums increase. Markets also start overshooting in both directions. That’s the exact type of environment where we can put our trading strategies to work.
We don’t need to know what the catalyst will be. But from over four decades of trading, I do know that markets don’t stay this quiet forever.
In the meantime, we’ll be patient and not to force trades. That way, our capital stays intact so we can really take advantage when volatility returns.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
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