Volatility, trends and time frames are three of the most commonly used and misused terms.
‘Volatility’ is often used as a synonym for downtrends. Yet, volatility is prices swinging sharply in both directions by big amounts. In mathematical terms, it can be equated to dispersion of returns. While no market has zero volatility, some assets have low volatility. Other assets have massive volatility, with prices showing high dispersion. Volatility could itself change if news flow changes. One popular measure is standard deviation from the mean.
A trend can be defined as a scenario where the price of today versus yesterday is the same as the change of yesterday versus the day before. If a trend is established, a trader can play it with confidence. Non-trending prices, on the other hand cannot be traded with much confidence. A trend-trading system does not guarantee returns, or establish targets. It does give clear rules for exits (as the system will close out the trade if the trend fails) and limits possible losses.
All such systems and definitions are actually dependent on the time frames of reference. Some traders trade intra-day; others look at single-session or two-session trades. Others look at trades within a settlement, while a few are willing to let a trade carry over across settlements.
Each type of trader will define volatility and trends differently, depending on time frames. What is volatility to a settlement trader could be a trend for a single-session trader. For example, a settlement trader could be hoping for an uptrend lasts as 10 sessions. If there’s a three-session downtrend within that period, a settlement trader will call it volatility. For a session-trader, that three-session move is a big trend in itself. For an intra-day trader, a two-hour up move is a trend, while it is volatility to a session trader.
If we look at the Nifty's daily movements since January 1, 2011, to June 10, 2016, (a total of 1,348 sessions), the statistics are interesting but also depressing in the implications. The average session has seen a movement or daily swing (the difference between the low and high prices) amounting to 1.3 per cent of the previous session's closing values. That's a large intra-day range.
There were 695 positive sessions and 652 negative sessions but the averaged return per session (negative and positive taken together) is a tiny, albeit positive 0.02 per cent. The index moved from 6,157 in January 2011 to 8,170 on June 10, 2016. That’s a compound annual growth rate (CAGR) of 5.3 per cent - inflation was well above that level and beat that return hollow for much of the period.
The standard deviation was 0.76 per cent/session, also reasonably high. The median was 1.14 per cent. An amazing 88 per cent of the sessions came in somewhere between the average plus or minus one standard deviation. The daily range is very thickly clustered, between 0.54 per cent and 2.07 per cent. At least 738 sessions were trending — direction of change in a given session (whether up or down) was the same as direction of change in the previous session.
There is no non-discretionary way to make a great return through this 66-month period, given high daily volatility, low averaged returns and the low long-term CAGR. A passive long-term investor would not have got great returns through this period. A trend-follower, who traded session by session, or settlement to settlement, may have received slightly better returns. The high intra-day volatility leads to a temptation to day-trade or to trade short-term. There, too, most intra-day trading systems would generate more brokerage than profits.
The author is a technical and equity analyst
