Mandelbrot had it right when he said, large changes tend to be followed by large changes, of either sign, and small changes tend to be followed by small changes.
Don’t believe him? Well its true! To illustrate this point, I’m posting three graphs of clustered volatility for General Electric (GE), Intel (INTC), and Cisco Systems (CSCO).
You might wonder, why this fascination with volatility clustering? Why should you care? The answer is quite simple. If you understand that stocks and the markets go through cycles of high and low volatility, you can position yourself appropriately.
Being able to predict volatility clusters or identify a genuine buying opportunity (this is the basis for my S&P500 Volatilty Timing Model (PDF)) from just noise can make you rich. Still not convinced? Just graph in Excel the absolute (or squared) % returns for any asset of your
choosing over a long time period. You can use daily, monthly, even 5 minute time periods. You’ll see the same thing over and over again, periods of low volatility are clumped together and periods of high volatility are clumped together.
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