You would think investors have become acclimated to the new market; since last summer volatility has been king and more recently it's making a bigger comeback. I wanted to put some thoughts together about the current situation, to try to make some sense of it. I recently heard that professional money managers are increasing their portfolio cash levels to higher levels than previously seen. Historically, these guys are cash averse and equity prone, but recent market action has even coerced professionals into the most conservative positions. One thing is for certain; market risk has risen for equity bulls AND bears alike. How long will it last, and what damage has already occurred? Is this recent rise in volatility just a flash in the pan or perhaps a prelude of things to come?

Risk levels have been high for quite some time, but they haven't really been 'considered' for a long time. When uncertainty in markets arises, then risk assessment levels are adjusted upward to compensate for the uncertain outcome. In the bond market, Chairman Greenspan would constantly talk of a 'conundrum', the disconnect between yield spreads, inflation expectations and economic growth. Why were longer term yields so low for a very long time relative to short term rates? Option volatility rises as the cost for protecting the downside increases. No longer is insurance considered 'cheap' because the demand is high. Stock prices have are still down almost 14% from their highs and more downside action is probable. When markets drop, they drop fast, REALLY FAST. Who has time to think what to do when your investment account is falling like a rock? What's the natural reaction? Sell, get me out, I'm done with it. Sometimes it's a full out P A N I C, can't stand the pain anymore.

What may explain the recent volatility, and further, the divergence in advancers and decliners? A little history is in order. Way back in the 1930's, the SEC instituted the uptick rule after a major bear raid nearly destroyed the markets in the 1929 crash; basically, you could only go short a stock after a buy, or uptick. This rule had been in place for more than seventy years, and most had deemed it old and useless. But, the removal of the rule simply let the bear genie out of the bottle. Can you imagine a boxer who gets knocked down to the canvass, and the other boxer continues to beat on him mercilessly without letting him get up off the ground? This is what the bears or short sellers got as a gift from the SEC, who incidentally, picked the exact WRONG time to remove the rule (with markets at or near all time highs, and ripe from the picking by shorts). Is it any coincidence that the rise in volatility came just after the removal of this arcane rule?

Certainly, since the removal of the uptick rule the markets have not disintegrated, but the removal may not help minimize volatility. No matter what underlying cause of the last 8 months of volatility (sub-prime, earnings, globalization etc.) the longer it saturates the market the more accepted it becomes. Bottom line is that volatility is here to stay and investors should acclimate. It was disheartening to hear that professionals are running to cash, the opportunities are still out there; your stomach just needs to understand the fundamental change in market dynamics: volatility is here to stay.

How to manage your own volatility is quite unique. We all are blinded by emotional responses when trading; it's natural. Even the best and most solid traders succumb to the evils of fear and greed at some point. It's the management of these emotions that separate the winners from the losers. Above you'll find a spectrum of volatility. The closer you are to the middle, the better you have your emotions in check. I trade with some emotion, but try to keep it contained. I find myself more toward the cautious level when I'm fearful, and confident when I'm feeling invincible. Check your emotions when you are trading or investing, and see where you might be on the spectrum.

The VIX may be flashing panic levels...or is it? 30% volatility is high from a historical perspective, but is not unprecedented. We saw markets rise in 2004 as the volatility index increased late in the year, and back in the mid 1990's the same thing occurred, prior to massive price explosion. But in 2002, volatility rose from the 20's to the 40's as the bear market swiped through with reckless abandon. More often than not, however, a sharp increase in volatility is short-lived, but this time we're expecting a longer term rise in volatility. A wound can expose weakness, and the sub-prime wound is exposing our increasing co-dependency with foreign markets; and it's those foreign markets that will support long-term volatility.

Price Headley is the founder and chief analyst of BigTrends.com.