Getting Volatility Into The Palm Of Your Hand

For traders, volatility is certainly their friend. It can create immediate trading opportunities with wild swings in markets and individual instruments - to wit, the financial markets the past few weeks in reaction to the COVID-19 virus.

At Excalibur Pro, we think volatility can help identify some longer term trends as well. Take palm oil, for example. We look at the one-month rolling average for volatility (and returns) to smooth some of the daily gyrations as a means of seeing longer-term trends. On December 27, palm oil's rolling one-month volatility was at 0.8. Fast forward to now, a little under three months later, and that rolling volatility skyrocketed to 2.6.

What often comes with higher volatility values is a decline in value. And that's exactly what happened with palm oil. From December 27 through March 23, palm oil has fallen 23%. We also think it is important to look at rolling volatility in conjunction with other indicators. For example, back at the end of December, palm oil's relative strength index (RSI) was at 85 - significantly above the overbought value of 70. A month later, it began to pierce some important moving averages (the first to go was the 50-day moving average and the 100- and 200- day followed).

And the Markov bear signals actually began to rise before volatility shot significantly higher.

So where does that leave palm oil today? The price has stabilized in recent days. As has volatility - but volatility remains high at that 2.6 value. The RSI has fallen to around 41 - nearing the oversold value of 30 but not there yet. All of which probably indicates flat trading in palm oil for now.

An interesting aside in the palm oil play - the Indonesian Rupiah and the Malaysian Ringgit. These two countries produce more than 80% of the palm oil around the world, so, their economies are usually closely tied to palm oil. The rupiah's correlation with palm oil has slipped to an almost meaningless value of 0.2 (looking at the 5-day average correlation). But that's because the rupiah finally began to react to palm oil's declines and has been falling faster recently. The ringgit is fairly closely correlated and has been slipping with the declines in palm oil.