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Wednesday, March 6th 2019

Are You Still Using Close-to-Close Historical Volatility?

The May 2010 flash crash shows the weakness in the traditional historical volatility calculation, close-to-close. ORATS uses a modified Parkinson method that has open high low close OHLC.

Summary

The May 2010 flash crash highlighted the weakness of using close-to-close historical volatility (HV) calculations. ORATS uses a modified Parkinson method that incorporates intraday moves, resulting in a one-day HV calculation and more accurate results. Traders should consider switching to this method.

"At 2:32 pm on May 6, 2010, the S&P 500 careened 8% in just 36 minutes before rebounding with just as dramatic of a move." So starts Dominick Paoloni's paper on Timing the Market.

This got me thinking, "I wonder how much the historical volatility (HV) calculation that ORATS employs differed from what most people use, close-to-close HV on May 6, 2010."

A lot!

Below shows the ORATS HV 5-day amount 52.18% vs the close-to-close amount 25.18%, MORE THAN DOUBLE.

 

The trick is that ORATS HV utilizes the intraday moves in a stock in our calculation and close-to-close does not. This has an additional benefit of providing a one-day historical volatility calculation. Based on the methodology in the close-to-close calculation, this is impossible for that numeric.

Traders based so much of the characterization of the market based on historical volatility that you have to ask yourself, "Why are you still using close-to-close historical volatility?

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