Submitted by The Investment Shadow
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Harnessing Stock Market Volatility
If you were to Google "Stock Market Volatility", you would find a wide range of observations, conversations, reports, analyses, recipes, critiques, predictions, alarms, and causal confusion. Books have been written; indices and measuring tools have been created; rationales and conclusions have been proffered. Yet, the volatility remains.
Statisticians, economists, regulators, politicians, and Wall Street gurus have addressed the volatility issue in one manner or another. In fact, each day's gyrations are explained, reported upon, recorded for later expert analysis, and head scratched about.
The only question I continue to have about all this comical hubbub is why don't y'all just relax and enjoy it. Jon Methuen nailed it in his August 15, 2011 parody of the financial world's ridiculous obsession with "volatility". "A Reasonable Guide To Stock Market Volatility" is a must view --- but only for mature adults with a semi-sick sense of humor.
Decades ago, a nameless college Statistics professor brought me out of a semi-comatose state with an observation about statisticians, politicians, and economists. "In the real world", he said, "there are liars, damn liars, and any member of the groups just mentioned". An economist or a politician, armed with a battery of statistics, is an ominous force indeed.
Well, now all the economists and statisticians have high powered computers and the ability to analyze volatility with the same degree of certainty (or is it arrogance) that they have developed with regard to individual-stock risk analysis, economic and geographical sector correlation dynamics, and future prediction in general.
But the volatility (and the uncertainty it either causes or results from, depending upon the expert you listen to) persists.
Modern computers are so powerful, in fact, that economists and statisticians can now calculate the investment prospects of just about anything. So rich in statistics are these masters of probabilities, alphas, betas, correlation coefficients, and standard deviations that the financial world itself has become, mundane, boring, and easy to deal with. Right?
Since they can predict the future with such a high degree of probability, and hedge against any uncertainty with yet another high degree of probability, why then is the financial world in such a chronic state of upheaval? And why-o-why does the volatility, and the uncertainty, continue?
Why the Volatility and Uncertainty Continue
I expect that you are expecting an opinion --- yet another opinion --- on why the volatility is as pronounced as it seems to be compared with years past. I'll do that next. But, first a sentence or two on "uncertainty" --- the playing field of the NFL (National Financial League). An uncertain environment is the only "for real" certainty you will ever experience in investing. Every investment has some form of risk and uncertainty.
Volatility, on the other hand is simply a force of nature --- one that you need to embrace and deal with constructively if you are to succeed as an investor.
But this new force of nature, this extreme volatility that we have been experiencing recently, has been magnified by the darkest forces of the Dismal Science and the changes that it has encouraged in the way financial professionals view the makeup of the modern investment portfolio.
On the bright side, enhanced market volatility enhances the power of the equity and income security trading disciplines and strategies within the Market Cycle Investment Management (MCIM) methodology --- an approach to market reality that embraces market turbulence, and harnesses market volatility for results that leave most professionals either speechless or in denial.
But, with no statistical data necessary (or available) to support the following opinion, consider this simplistic rationale for the hyper-volatility of today's stock market.
Volatility is a function of supply and demand for the common stock of a finite number of dirty, evil, greedy, polluting, congress corrupting, job creating, product and service providing, innovation and wealth developing, foundation supporting, gift giving, tax-collecting corporations to finance their growth and development.
"Tax collecting" raise an eyebrow? Look at a rental car statement or your next hotel bill. Those greedy corporations collect more money for state and local governments than the income tax collectors --- but that is a whole 'nother issue.
Those of us who trade common stocks in general, IGVSI stocks in particular, owe a debt of gratitude to the real volatility creators --- the hundreds of thousands of derivative products that bring an entirely speculative kind of indirect supply and demand to the securities markets.
Generally speaking, the fundamental, emotional, political, economic, global, environmental, and psychological forces that impact stock market prices have not changed significantly.
Short term market movements are just as non-predictable as they have ever been --- they continue to cause the uncertainty you need to deal with using proven risk minimization techniques like asset allocation, diversification, and trading.
The key change, the new kid on the block, is the impact of derivative betting mechanisms on the finite number of shares available for trading. Every day on the New York Stock Exchange, thousands of stocks are traded, a billion shares change hands. The average share is "held" for mere minutes.
On top of derivative trading in real things such as sectors, countries, companies, commodities, and industries, we have a myriad of index betting devices, short-long parlor games, option strategies, etc. What's a simple common share of Exxon to do?
Market volatility is here to stay --- at least until multi-level and multi-directional derivatives are relocated to the Las Vegas markets where they belong.
Want more: Modern Portfolio Theory --- The Root Of All Evil