To test this I compared the 2-day average true range with the 20-day average true range. The ratio as of Thursday’s close in the SPY was about 0.53. I ran a test to see what happened when this ratio had dropped below 0.55 or lower going into a report. The basic expectation was that the contraction in volatility would reverse after the news was released and lead to an explosion in volatility.
The third column shows the true range on the day of the release vs. yesterday’s 20-day average true range. The average for the 9 instances was 0.94 – meaning the true range after the report failed to reach even average size (1). In the last column I showed the percentage gap that SPY opened the next morning.
You’ll probably hear a lot of hype about the importance of the number Friday morning. Don’t be too surprised if it turns out to be just that – hype. Historically after such contractions it hasn’t led to the volatility explosion that you might expect.
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