Bracing For August

Today is the last weekend before the start of August, a month that is traditionally known as the most treacherous month for the Malaysian stock market. In my monthly-updated Market Pulse column (see link), it is observed that the month of August has seen some of the greater monthly declines historically.

KLCI – what is next?

As mentioned in earlier posting, if it ever breaches the support zone of around 1,728, I personally feel that we may potentially see further downside bias. If it ever breaks the 1,800 resistance point, the index may be on an upside trajectory.

FBMKLCI.png

How should one deal with August?

There are numerous options that may be considered…

  • Focus on swing trading strategies with appropriate reward-to-risk ratio / risk management strategies
  • Bargain hunting for beaten-down value stocks / mid-large cap stocks (for purpose of long term investing)
  • Increase cash position (in money market funds)
  • Maintain status quo

Tracking Volatility

Short term volatility is greatest at turning points and diminishes as a trend becomes established.

George Soros

 

As shown below, the current volatility of FBMKLCI continues to remain low. If the volatility increases, this may indicate that a potential trend reversal is imminent.

hv.jpeg

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Volatility & Stocks Movement

Our assumed tenets about volatility and movement of stocks are as follows:

1. Volatility does not predict the direction of stock movement;

2. When volatility increases, we expect condition to be bearish and vice versa; and

3. When 10D moving average volatility crosses above 50D moving average volatility, this signals increase in volatility and thus will result in potential bearishness for the particular stock and vice versa.

Let’s take a look at how volatility is interrelated with the share price movement of Sapurakencana Petroleum (a Malaysian-listed O&G stock, “SKPetro”):

SKP_1_Vols.png

It is observed:

  • In general, when there were significant increases in SKPetro’s volatility (e.g Oct-Nov 14, Aug-Sep 15, Feb-Mar 16), there were declines in the share price of SKPetro.
  • The relationship (i.e when volatility rises, price should decline) appears weak in 2012-2013.
  • When SKPetro was trading sideways (e.g Oct 13- Sep 14), volatility declined

Volatility analysis is further analysed below, with the plotting of difference between 10D moving average volatility and 50D moving average volatility. As per our assumed tenets, when 10D MA breaches 50D MA (in few occasions shown in the graph below), we saw declines in the share price of SKPetro, in line with a more bearish sentiment / growing uncertainty. 

SKP_2_VolsFrom the above analysis, it is observed that we are currently seeing an increasing volatility for SKPetro (spike in volatility in May 2016), potentially signaling a ‘bearish’ outlook for SKPetro in the short term.

Implied Volatility : What The Market Expects

The following is an extract of currently traded structured warrants (with underlying “SKPetro”):

SKPEtro_iV.png

The future volatility of SKPetro is expected to trend higher, as shown in the above table whereby the structured warrants’ implied volatility are relatively higher than the underlying’s current historical volatility of 33.0%.

Concluding Remarks

It is very important to re-emphasize that the increase or decrease in volatility does not predict the direction of the stock movement. Higher volatility means more opportunities for trading.

DISCLAIMER: ALL ARTICLES CONTAINED IN THIS SITE ARE FOR INFORMATION AND ILLUSTRATIVE PURPOSES ONLY AND DOES NOT PURPORT TO SHOW ACTUAL RESULTS. IT IS NOT, AND SHOULD NOT BE REGARDED AS INVESTMENT ADVICE OR AS A RECOMMENDATION REGARDING ANY PARTICULAR SECURITY OR COURSE OF ACTION. SOURCES USED IN THIS SITE HAVE NOT BEEN INDEPENDENTLY VERIFIED FOR ACCURACY. YOU SHOULD SEEK INDEPENDENT AND PROFESSIONAL INVESTMENT ADVICE IN REGARD TO YOUR INVESTMENT DECISIONS. THE AUTHOR MAY HOLD POSITIONS IN THE SECURITIES MENTIONED ABOVE.

Volatility & FBMKLCI (Update)

Historical Volatility: What we know so far

Analysis of historical volatility or statistical volatility shows that in rising prices, volatility tends to be lower as risk or fear subsides. When prices are declining, volatility will tend to increase.

The graph below highlights the relationship between FBMKLCI and its historical volatility (annualised, 30day), 10 day moving average volatility and 50 day moving average volatility.

FBMKLCI_May16_Vols(1).png

As shown above (e.g period : Jan-Feb 2015, Sep-Oct 2015, Feb-Mar 2016), when FBMKLCI declines, the historical volatility increases.Even in the recent selloff in May 2016, we saw a spike in the statistical volatility.

It is important to note that as the 10-day moving average volatility moves above the 50-day moving average, the market conditions are turning bearish. And as the 10-day moving average moves below the 50-day moving average, the market conditions are expected to turn bullish. When the 10-day moving average diverges far apart from the 50-day moving average, the FBMKLCI will experience correction. Currently (in May 2016), we saw the 10D moving average volatility crosses above the 50D moving average volatility, signaling a bearish market condition.

Implied Volatility: What may happen next

Implied volatility is the market expectation of the future volatility. This can be imputed from the traded options. The following table shows the structured call warrants (with the underlying: FBMKLCI) that are currently traded on Bursa and will be expiring from August 2016 onwards:

FBMKLCI_May16_Vols(2).png

It is observed that the average implied volatility from these structured call warrants is 15.8% which is relatively higher than the current historical volatility of 9.3%(as of 27 May 2016). Market expects more volatility in the next few months. Unfortunately, volatility does not predict the direction of the underlying. Based on the implied volatility of the structured warrants, there is 68% chance (i.e based on 1-standard deviation) that FBMKLCI may trade between 1,335.5 and 1,938.9 up to 31 Jan 2017.

 

DISCLAIMER: ALL ARTICLES CONTAINED IN THIS SITE ARE FOR INFORMATION AND ILLUSTRATIVE PURPOSES ONLY AND DOES NOT PURPORT TO SHOW ACTUAL RESULTS. IT IS NOT, AND SHOULD NOT BE REGARDED AS INVESTMENT ADVICE OR AS A RECOMMENDATION REGARDING ANY PARTICULAR SECURITY OR COURSE OF ACTION. SOURCES USED IN THIS SITE HAVE NOT BEEN INDEPENDENTLY VERIFIED FOR ACCURACY. YOU SHOULD SEEK INDEPENDENT AND PROFESSIONAL INVESTMENT ADVICE IN REGARD TO YOUR INVESTMENT DECISIONS. THE AUTHOR MAY HOLD POSITIONS IN THE SECURITIES MENTIONED ABOVE.