Volatility Works Both Ways
Volatility is a two-way street, but understanding the market environment will help you predict when sentiment is changing
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We interpret and explain price moves in real-time, 24 hours a day. Our team of analysts produce text, video and audio commentary.
You understand the markets and trade with confidence. Learn more at our website here: https://financialsource.co
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We have a quick question from Wayne who say that today’s trading session started with a strong risk off tone in the market, but at the European session open bond futures dipped lower and asks why was that?
Thanks for the question Wayne. I think it’s a great question that allows us to talk about market volatility. For those of you who don’t know, Wayne is referring to bonds because whenever we have a strong risk on or risk off tone, we would expect bonds to react in a specific way, as we would also expect other asset classes like equities and commodities and FX to react in a specific way.
Now, in today’s session, which is 30 October 2020, we started out with a strong risk off tone, but from after the cash open we saw a bit of mild downside in bonds, possibly pointing to a change in the risk tone. So, when this happens the first thing to do is try to look for possible reasons why that might be the case.
If you see that nothing has hit the news wires that could potentially explain the move, look through other movements across asset classes to see if there is similar reactions. If we taka a look at equities we can see that equities had a similar run higher at that time. Now, was there any fundamental news flow to cause that move at that time, nothing really that I could see from my side.
So, if there is no news that explains it and we see similar moves across other asset classes, it might be pointing to a correction in the overall risk tone in the market. Of course, this can happen for a couple of different reasons, it might be down to the normal ebb and flow of the market, it might be down to month-end flows seeing that it’s the last trading day of the month, it might be due to some de-risking or profit taking on long bond positions for some reason.
But, in a session like today, and more specifically this whole week really, I think it’s down to volatility. Remember, during weeks like these where we have thinner liquidity environments and lower volume, we can either expect very muted and lacklustre moves, or we can expect large exacerbated moves, and that volatility works both ways, which means with the same speed and pace that we saw downside moves this week, volatility can cause the market to have similar reactions in the other direction as well, whether it’s due to any of the reasons we mentioned it’s hard to say, but one of the reason why we choose to stand clear and remain patient when trading conditions are like this.
Markets might be risk off one second and risk on the next without any real change in the overall sentiment at all. And it’s these environments that can really chew into your profits because there is really no clear direction. Now, of course, whenever we see these types of environments in terms of volume and liquidity and heightened volatility, there is arguably a higher probability for risk off flows compared to risk on flows, but again due to this type of uncertain environment it’s not really a funny thing to see out-sized moves in either direction without any real obvious cause in the market.
Now, it’s always important to keep common correlations in mind, like risk flows, but other times it might be something completely unrelated causing such moves.
For example, in our first video of the day we highlighted that the US 5-year forward inflation expectations saw some upside yesterday, now rising inflation expectations is usually a negative for fixed income securities like bonds, which can explain some of the upside, but as usual in the markets it might be a whole range of factors compared to just that one thing, and with market conditions like this it can be quite tricky to pin point the exact cause because correlation does not necessarily mean causation which is important to keep in mind.
So, hope that helps with your question Wayne, any others please let us know.
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If you find this content helpful, you’ll love Financial Source.
There’s a link below were you can learn more about it
https://financialsource.co
----
We interpret and explain price moves in real-time, 24 hours a day. Our team of analysts produce text, video and audio commentary.
You understand the markets and trade with confidence. Learn more at our website here: https://financialsource.co
-----
We have a quick question from Wayne who say that today’s trading session started with a strong risk off tone in the market, but at the European session open bond futures dipped lower and asks why was that?
Thanks for the question Wayne. I think it’s a great question that allows us to talk about market volatility. For those of you who don’t know, Wayne is referring to bonds because whenever we have a strong risk on or risk off tone, we would expect bonds to react in a specific way, as we would also expect other asset classes like equities and commodities and FX to react in a specific way.
Now, in today’s session, which is 30 October 2020, we started out with a strong risk off tone, but from after the cash open we saw a bit of mild downside in bonds, possibly pointing to a change in the risk tone. So, when this happens the first thing to do is try to look for possible reasons why that might be the case.
If you see that nothing has hit the news wires that could potentially explain the move, look through other movements across asset classes to see if there is similar reactions. If we taka a look at equities we can see that equities had a similar run higher at that time. Now, was there any fundamental news flow to cause that move at that time, nothing really that I could see from my side.
So, if there is no news that explains it and we see similar moves across other asset classes, it might be pointing to a correction in the overall risk tone in the market. Of course, this can happen for a couple of different reasons, it might be down to the normal ebb and flow of the market, it might be down to month-end flows seeing that it’s the last trading day of the month, it might be due to some de-risking or profit taking on long bond positions for some reason.
But, in a session like today, and more specifically this whole week really, I think it’s down to volatility. Remember, during weeks like these where we have thinner liquidity environments and lower volume, we can either expect very muted and lacklustre moves, or we can expect large exacerbated moves, and that volatility works both ways, which means with the same speed and pace that we saw downside moves this week, volatility can cause the market to have similar reactions in the other direction as well, whether it’s due to any of the reasons we mentioned it’s hard to say, but one of the reason why we choose to stand clear and remain patient when trading conditions are like this.
Markets might be risk off one second and risk on the next without any real change in the overall sentiment at all. And it’s these environments that can really chew into your profits because there is really no clear direction. Now, of course, whenever we see these types of environments in terms of volume and liquidity and heightened volatility, there is arguably a higher probability for risk off flows compared to risk on flows, but again due to this type of uncertain environment it’s not really a funny thing to see out-sized moves in either direction without any real obvious cause in the market.
Now, it’s always important to keep common correlations in mind, like risk flows, but other times it might be something completely unrelated causing such moves.
For example, in our first video of the day we highlighted that the US 5-year forward inflation expectations saw some upside yesterday, now rising inflation expectations is usually a negative for fixed income securities like bonds, which can explain some of the upside, but as usual in the markets it might be a whole range of factors compared to just that one thing, and with market conditions like this it can be quite tricky to pin point the exact cause because correlation does not necessarily mean causation which is important to keep in mind.
So, hope that helps with your question Wayne, any others please let us know.
-----
If you find this content helpful, you’ll love Financial Source.
There’s a link below were you can learn more about it
https://financialsource.co
