Everyone - opponents and proponents
alike - admit that stock returns do change with time, though for
different reasons.
Volatility is a form of market inefficiency. It is a reaction to
incomplete information (i.e., uncertainty). Excessive volatility is
irrational. The confluence of mass greed, mass fears, and mass
disagreement as to the preferred mode of reaction to public and private
information - yields price fluctuations.
Changes in volatility - as manifested in options and futures premiums -
are good predictors of shifts in sentiment and the inception of new
trends. Some traders are contrarians. When the VIX or the NASDAQ
Volatility indices are high - signifying an oversold market - they buy
and when the indices are low, they sell.
Chaikin's Volatility Indicator, a popular timing tool, seems to couple
market tops with increased indecisiveness and nervousness, i.e., with
enhanced volatility. Market bottoms - boring, cyclical, affairs -
usually suppress volatility. Interestingly, Chaikin himself disputes
this interpretation. He believes that volatility increases near the
bottom, reflecting panic selling - and decreases near the top, when
investors are in full accord as to market direction.
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