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The Wildest Ride
Up, down. Way up, way down. Stock volatility has reached historic levels -- as one market expert said, "We have no idea where things are going."

By Renae Merle
Washington Post Staff Writer
Tuesday, October 21, 2008

The market's wild hour-by-hour swings have come to exemplify the turbulence of the financial crisis, but they're still puzzling for many market professionals.

The Dow Jones industrial average now routinely travels hundreds of points in a matter of hours, only to reverse direction in many cases. During a single day earlier this month, the Dow spanned 1,000 points for the first time in history. On another, a 400-point rally during the last hour of trading sent the Dow to a historic 936-point gain.

During the final hour of trading yesterday, the Dow surged more than 100 points.

Financial analysts suggest that the sharp ups and downs reflect investors' uncertainty about how quickly the financial crisis can be resolved and whether a recession will seep from the banking sector to other parts of the economy. Precipitous gains and losses have also been triggered as stocks reach pre-set selling or buying levels, prompting automated trading and causing investor whiplash, analysts said.

The largest swings have often occurred during the last hour of trading, prompting a closer look by the Financial Industry Regulatory Authority, a nongovernmental regulator of securities firms. The end of the trading day is when institutional investors, including hedge funds and mutual funds, rush to meet client demands to pull cash out of the market, analysts said.

The gyrations have turned even seasoned market professionals into skittish investors, waiting for a news tidbit that will turn the market's mood and start a stampede in either direction. "Psychology and emotion are a big part of what moves the market," said Andrew Brooks, head of stock trading at T. Rowe Price. "We are clearly in a highly emotional and schizophrenic point."

The Chicago Board Options Exchange's Volatility Index, known as VIX, has become a daily ticker of investor anxiety. VIX measures the degree to which investors expect stocks to swing and is often called the "fear gauge." It closed at 70.33 on Friday, its highest close ever, and hit an intraday high of 81.17 last week. In normal times, it trades at about 15 to 20, analysts said.

"We have no idea where things are going. That is what high volatility means," said Robert F. Engle, a finance professor and director of the Center for Financial Econometrics at New York University.

The volatility measure declined to 53 yesterday as Wall Street celebrated early signs that government efforts to thaw the credit markets could be working.

But analysts said they expect the volatility to continue for some time, perhaps through the end of the year. The market volatility provides an opportunity for some traders to make money off abrupt changes, analysts said. "It's bad for us, but somebody is thriving on this volatility," said Ashwani Kaul, director of research at Thomson Reuters. "Whenever there is volatility, somebody is making money."

The last sustained period of volatility was from 2000 to 2003, after the collapse of the Internet bubble and the Sept. 11, 2001, terrorist attacks, Engle said. "We have dramatically exceeded what happened in that period," he said.

But the current volatility does not compare with the Great Depression, Engle said. "The news during the Great Depression was even more dramatic. We had thousands of bank failures. We had 30 percent unemployment during some of the Depression," he said. "The stock market dropped 70 percent instead of the 35 percent to 40 percent we have now. It was a much bigger economic catastrophe."

Analysts said that some of the recent volatility could have been avoided if investors began reevaluating the market sooner, perhaps after the near failure of Wall Street investment bank Bear Stearns in March. Some volatility occurs as investors hastily reappraise the value of entire sectors instead of doing this gradually over time, they said.

"If the smart investor had been pulling out and pulling out, we would not have had this precipitous drop," Kaul said.

The most volatile part of the day has become the last hour of trading as hedge funds and mutual funds face pressure from clients to cash in their investments.

Traders are sometimes given a set basket of shares to sell and spend most of the day trying to get the best price they can, analysts said. But at the end of the day, many must go all out with little regard for price to meet their goals.

"Just to get to that level of cash that their bosses are dictating, instead of working the order, they are selling it for whatever," said Art Hogan, chief market analyst at Jefferies & Co.

According to TrimTabs Investment Research, investors pulled $43 billion out of hedge funds in September, the largest one-month withdrawal in history. About $22 billion was taken out of U.S. equity mutual funds last month, another record. October is expected to be worse.

"We're clearly seeing forced selling," said Tobias Levkovich, chief U.S. equity strategist for Citigroup Investment Research. "If you owned a stock that fell 60 percent over three or four months, the only reason you would sell it now is because you have to."

The Financial Industry Regulatory Authority also confirmed yesterday that it is looking into whether the historic late-day volatility is related to investor manipulation. The agency is examining whether traders have been inappropriately setting artificial stock prices out of line with the day's trading level during the last 20 minutes of trading, a period known as "market on close."

The swings have been unnerving for some investors. "The 3 to 4 o'clock hour has been hijacked by some of these hedge funds and major mutual funds, whoever has huge trading volume," Kaul said. "It takes a massive amount of money and volume, but if they want to drive it up, they drive it up. If they want to drive it down, they do."

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