Volatility compression
What does an unusually quiet week in a market tell a trader about risk and about what may come next?
In plain words
Volatility compression is a stretch of time when a market's price swings become unusually small compared with its own recent history. Traders watch it because tight ranges often build pressure that is released in a larger move, though the timing and direction of that move are not given by the quiet itself.
Why it matters
Positions sized for normal conditions can seem safe during a quiet week and become badly oversized if volatility expands. Compression also tends to depress options prices, making protection cheap before it is needed. The quiet is a state, not a signal: it says nothing about which way the eventual move will go.
In a real week: ETH, week of 7 August 2023
In the week of 7 August 2023, ETH's realised volatility was 18.1% a year and its full-week range was 4.13%, with the high of 1876.51 on Tuesday and the low of 1802.0 on Monday. Its largest single hourly move was -0.64%, and its return of 0.57% sat at the 50th percentile of its 286-week history. Dollar volume of 1.99 billion was 0.55 times the prior 12-week average, confirming how thin activity was.
A common mistake
Treating compression as a promise that a large move is imminent or a clue about its direction. Quiet conditions can persist for weeks, and the eventual break may be smaller than expected.