Will volatility increase now that those who have taken the saying “sell in May and go away” to heart are back?
What the heck does “Sell in May and Go Away” mean?!
The phrase, used more widely in the equities markets, refers to traders cashing in their high-yielding investments ahead of the summer months (usually June to August).
With traders out on vacations, the months following May usually see significant drops in trading volume. This creates a self-fulfilling prophecy of selling in May followed by months of low volume (and sometimes low volatility) trading, which is why it’s better for most traders to just “go away.”
So does it follow that volatility will increase in September?
Should we expect to see volatility increases now that those who have taken their summer vacations are back on their trading desks?
I looked at the volatility of the Dollar Index and the major currencies (vs. USD) in the last five years for answers. I used the Average True Range (ATR) on the August and September months to see if there are any tendencies we can take advantage of:
Based on the chart above, we now know three things:
1. Volatility direction is pretty much consistent across the board
While volatility doesn’t ALWAYS pick up in September, we know that when it does or doesn’t, then that will be true for the major currencies AND the Dollar Index.
Don’t discount currency-specific events though! Not only can they break the overall pattern, but they also determine how big volatility changes are for specific currencies.
As for the intensity of volatility changes, look no farther than AUD’s 77% volatility increase in 2014 when the RBA got busy with its jawboning. And then there’s EUR’s 24% drop in volatility in 2015 when the Greek elections and mixed rhetoric from ECB officials kept traders in the sidelines.
2. Certainty is key
If you haven’t guessed by now, then you should know that clarity and certainty are key to increases in volatility.
Back in 2014 major central banks were clear with their policy biases. Heck, some of them even walked the talk!
Draghi announced the ECB’s plans to buy asset-backed securities; the Fed confirmed that it’s working on an “exit” strategy; Mark Carney all but promised a rate hike, and the SNB straight up intervened in the markets. As for the comdolls, well, we were pretty “certain” about our concerns over China’s economy and a slowdown’s impact on commodity demand.
And then there’s September 2015, which suffered a 16% average decrease in volatility. And while a volatile August trading made September’s decline more pronounced, threats of a U.S. government shutdown and Greek election results also contributed to a muted trading environment.
Now we know that if traders are confident about a central bank’s policy direction, then they’ll likely be more comfortable in loading up on their bets when they come back from their vacation.
3. August 2017’s volatility is basic
That is, it’s pretty much consistent with the previous years’ average volatility this time of the year at 608 points for USDX and an average of 82 pips for the rest of the currencies.
Question is, are we headed for increased or decreased volatility in September 2017?
Much like in 2014, market players are expecting big things from the Fed and ECB this year. The Fed is expected to start putting back the “balance” back in “balance sheet” while Mario Draghi and his gang could start talking about tapering this month.
Volatility-killing risks remain, however. For one, talks about the looming debt ceiling deadline as well as Trump’s ability to deliver his tax reform plans could wreak havoc on the dollar’s trends.
Threats of a nuclear war with North Korea could also escalate especially if talking it out isn’t working. Last but not the least, jawboning from central banks like the RBA, RBNZ, and SNB could limit uptrends for their respective currencies.
While increased volatility isn’t as certain as we’d like it to be, it doesn’t mean that you should sit back and extend your vacation plans.
In fact, you should start getting back in your trading zone so you’ll be prepared for whatever catalysts that may come in the next few weeks.