'Normal Volatility' is an Oxymoron

So, I'm half watching financial TV yesterday and, lo and behold, they start talking volatility. And guess what? The guest expected volatility to rise next year. This was shocking, of course, because no TV guest ever expects higher volatility on the horizon. And by none of them, I really mean all of them. But here's where he got my anger buzz up: he referred to what we've seen recently (presumably this year and/or a more extended time frame) as abnormal. And next year's volatility lift will merely return us to "normal."

Oh, where to begin?

First off, disabuse yourselves of any notion of "normal" volatility. There is no such animal. Yes, volatility can have a typical level, what we generally call a "mean." And we all look for mean-reversion of some form. The problem is that there's no single "mean" when defined this way. We can, of course, calculate moving averages. But then it comes down to time frames. Today's mean is yesterday's moonshot and tomorrow's implosion. And besides, "median" is a better statistical measure of the CBOE Volatility Index's (VIX) history, thanks to the occasional wild outliers. When we go after mean-reversion, we are really trying to figure out how far VIX is from a typical and expected level. Median expresses that better.

Since inception, VIX has a median of 18.46. So, any time it's below that, we should expect a rise, and any time it's above that, a decline, right? Well, I suppose -- but you might go broke waiting. Not to mention that by that definition, VIX was actually quite high over this past week. It went past "normal." The peak close of 23.57 is as abnormal as a close of 13.5.

But again, that's a bad lens through which to view VIX. I occasionally mention the concept of longer-term VIX regimes -- they last about four to six years. They are very loosely defined, but means and medians within those regimes give us a way better sense of a "normal" to trade against. Here's a look at means and medians in some of those loosely defined regimes:

Through the lens of these regimes, VIX actually got rather high this past week. We didn't just return to "normal" -- we went way beyond the station. So yes, the guy on TV could prove correct. "Normal" might change. This week's high is conveniently just about the same as the median from 2007 to 2010. And hey, it's the end of a four-year-low stretch, and that's also conveniently the time frame I used to break out the regimes.

My only real point is that "normal" is a moving target and that it's easier to predict a lasting volatility lift in words than it is to predict it in profitable investing and trading strategy.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.