Making Sense Of The Increase In Volatility

If one was out and about on Tuesday and unable to view the intraday action, the end result of the trading session may not have produced much of a reaction as the Dow fell 27 points, the S&P dropped 5, and the NASDAQ gave up just 3.

However, anyone watching the day unfold knows that there was a lot more to the story.

The word of the day was volatility. Although analysts have bemoaned the lack of volatility seen in the stock market on a big-picture basis (there was just one 5% correction in 2014 and this remains the third longest period in history without a 10% pullback), the intraday action has been wild and woolly of late.

Take yesterday for example. The early futures action in the wee hours Tuesday suggested stocks would open higher. Traders then ignored a further drop in oil prices and doubled the pre-market gain within the first half hour of trading.

And before you could pour that second cup of coffee, the Dow was sitting with a gain that was pushing 300 points (283 to be exact) and there was talk of stocks "decoupling" from the worries about oil.

But then things got interesting. Very interesting. From about 8:00 am eastern until about 2:15 pm, stocks proceeded to fall precipitously. While the move was clearly algo-driven at times, it did not appear to be entirely algo-induced.

Related Link: Is It Time To Rethink Your Investment Strategy?

Suddenly the big gains were gone and the indices were in the red. And at one point, the Dow was down more than 150 points.

Why The Dive?

The question, of course, was why had stocks suddenly fallen out of bed? Oil, which had appeared to be the primary driver of intraday prices on Monday, was falling, but actually rebounded in the afternoon. And there weren't any headlines that would account for the big reversal in stock prices.

After digging around, we found a couple potential catalysts. First, we discovered that the Russian ruble, after stabalizing for a while during the holiday season, was crashing again. Why do we care? In short, the words you are looking for are "emerging markets currency crisis." Yep, we could be back to that.

In addition, there was word that officials at Germany's Bundesbank had said that they were not on board with the ECB launching a QE initiative. And with just about everyone under the sun expecting Super Mario to introduce a sovereign bond buying program - and soon - this news created doubt about the fate of the eurozone as well as the overall global economic picture.

So there you have it. Just like that, the optimism from Alcoa's earnings beat was gone and fear was back. As such, investors were treated to a 425 point roller coaster on the Dow.

What Do the Charts Tell Us?

One of the takeaways from the charts is, so much for that V-Bottom that everyone was talking about late last week. It is now clear that stocks are in a more complex bottoming process with some suggesting that the bottom of the pullback which began back on December 30th, may not yet have been seen. The current price action is tracing out a "wedge" formation, which is traditionally a consolidation pattern. Thus, one can argue that the current action is merely a sideways digestion of the big move up seen in October and November.

Related Link: What Do The Cycles Say About 2015?

The key however, will be the direction in which prices break the wedge. The textbooks tell us that a decisive break above the short-term downtrend line would suggest new highs ahead while a move below the short-term uptrend could produce additional "price discovery" to the downside.

S&P 500 SPY - Daily

Although intraday volatility has increased dramatically over the past month, the good news is that the major indices have not broken down into a meaningful decline. And from a short-term view, prices do indeed appear to be consolidating.

S&P 500 - Weekly

However, from a longer-term perspective, the stock market doesn't appear to be overly concerned about oil, Russia, Europe's QE, China, etc. Therefore, the proper takeaway from yesterday's intraday hysterics might be, all's well that ends well. We shall see.