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December 16, 2011

Volume and Volatility: The Comeback Kids

Top Stories in 2011

By James Armstrong

The year began with low volume and little volatility, and then changed rapidly midyear, making 2011 a year of stark contrasts. Usually, the end of July and the month of August are the summer doldrums, when not much happens. This year, it was when everything changed.

Both volume and volatility skyrocketed this summer. The VIX volatility index went from under 15 in April to a peak of 48 in August. Volume levels tended to mirror volatility, with monthly consolidated volume jumping more than 74 percent from July to August. (Volume this August was 53 percent higher than the same month last year.)

"We view the period from July 25 to the present as a radically different execution environment, versus the first half of the year," said Tim Reilly, head of North America electronic execution sales at Citi.

Reilly compared the market turn at the end of July-and the August sell-off that followed-to other recent game-changers, such as the quant meltdown of 2007, the financial crisis of 2008 and the "flash crash" and its aftermath in May 2010.

As the markets became more volatile in the second half of this year, bid-offer spreads went up, especially for small- and mid-cap stocks, he said. Those spreads have now stabilized at new, higher levels, which have proven to have staying power.

The defining challenge in the first half of the year was liquidity discovery, but with the intraday volatility starting in late July, Reilly saw an escalation in concerns about short-term trading strategies. Those concerns dampened somewhat when the market started going up, he added.

Though volatility-and the high volumes that typically go along with it-could go down, most traders are not looking for that to happen anytime soon.

"Just when you think we're about to go back to those low volumes that we saw at the beginning of the year, something else creeps up that keeps volatility ratcheted up," said Ed Brown, executive vice president for business development at the interdealer broker ICAP.

Brown said that while few people saw the sea change in markets coming, the obvious signs were all there in the macro environment. During the first half of the year, traders might just have overlooked some of those signs as they were so focused on regulatory issues, he added.

Phil Lynch, chief executive officer of Asset Control which provides economic data to investors, said volatility will likely continue into the coming year.

"There are periods where the volatility is going to spike, but the trend is that the time frame in between those is going to be much shorter," Lynch said.

Markets today are more electronic and far more global than they were only a few years ago, and with so much rapidly moving capital today, volumes and volatility are bound to rise, he added.

 

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