- 1998: Volume 7, No. 6 T-Bond Futures: Price Trendiness & Price Volatility

Having traded and commented on the markets for years, I have heard many times the start of a trend is marked by rising price volatility. Wondering if that was truly the case I asked, when the market begins a trend, does price volatility usually increase? If that is the tendency and you suspect a price trend is beginning, then volatility can be used as a confirming indicator.

Definitions

Before I hand that question to the computer, subjective terms like "trends" and "price volatility" must be defined.

Lows & Highs— I use the 20-day moving average of the closing price to identify reactionary lows and highs. When the market crosses above the 20-day average, the previous low price is considered a reactionary low. When the market crosses below the moving average, the previous high price is considered a reactionary high (see figure 1).

Figure 1

Figure 2

Trends— An uptrend exists when the distance between a successive low and high is more than four points and more than 15 days. The uptrend's low marks the beginning of the trend (see figure 2). A downtrend exists when the distance between a successive high and low is more than four points and more than 15 days. The downtrend's high marks the beginning of the trend.

Price Volatility—The day-to-day movement of the T-bond future is measured by the daily absolute price change. Let's say a series of daily price changes are +5, -10, +5, -5, -10, 0, +5, -5, +10 and 0. The price volatility this 10-day period averages 5.5 ticks per day. That is, each day the T-bond varies from its previous closing price an average of ±5.5 ticks.

Approach

To answer the topic question, I examined the change in price volatility for the 10-day period before the start of each trend and compared that figure with the price volatility of the initial 10-day period of the trend.

Test & Results

I examined the T-bond future's price data of the past 10 years. There were 43 market moves that satisfied my definition of a trend (25 uptrends and 18 downtrends). For example, on Oct 11, 1990 a low occurred and the T-bond began a trend that would push it up 9-21 points in the following 43 days. The 10-day period prior to the start of the uptrend (Sep. 28 to Oct. 11) the daily absolute price change averaged 16.9 ticks. The initial 10-day period of the uptrend (Oct 12 to Oct 25) the daily absolute price change averaged 12.7 ticks. In the beginning of this uptrend price volatility fell (see figure 3). In the initial 10-day period of the 43 trends, the volatility increased 21 times, decreased 21 times and remained unchanged once.

Figure 3

Figure 4

Comments

The results are a wash and do not support the conventional wisdom that the start of a trend is marked by an increase in volatility.

Price trendiness and price volatility are different things. Generally speaking, a price trend is a function of the direction of the price changes. Price volatility is a function of the size of the price changes.

Looking at the top diagram in figure 4, the market is trendless—the number of up and down changes are equal and the price moves sideways. However, the size of the daily changes or the price volatility rises.

In the diagram at the bottom of figure 4, there are more up changes than down changes and the market trends up. However, the size of the daily price changes or volatility falls.

The next time you suspect a trend is beginning, don't be swayed by the change of price volatility. At that moment you are better-off looking to conventional measures like changes of volume or open interest to determine whether or not a price trend has truly begun.

Alex Saitta is a technical analyst with Salomon Smith Barney where he is assisted by Yuxin Li. He is a frequent contributor to CRB Trader.