Short Look at the Volatility Index
The $VIX volatility index is defined as a weighted measure of the implied volatility of the S&P 500, which provides a view of investors' expectations on future market volatility. VIX values greater than 30 are generally associated with a large amount of volatility as a result of investor fear or uncertainty, while values below 20 generally correspond to less stressful, even complacent times in the markets. Based on yesterday’s close when the VIX approached 10, the times, they are complacent! But will the times begin changing soon? There are some characteristics of the technical chart of the VIX that suggests volatility may be jumping soon. To me, it looks spring loaded to jump. But, are there bullish or bearish implications for the stock market? This article presents a concise look at the technical chart of the $VIX volatility index.
Below is a long term weekly chart of the $VIX from 1997 to the present, showing the S&P price action in the bottom pane. From this one can see that peaks in the VIX corresponded directly with intermediate term bottoms in the S&P 500. While peaks in the VIX corresponded with market bottoms the opposite cannot be said for bottoms in the VIX. By and large, bottoms in the VIX do not correspond to intermediate term tops in the S&P 500. However, the major top in the S&P 500 which occurred in 2000 corresponded with an intermediate term bottom in the VIX.
The next chart depicts the long term smoothed trends between the VIX and the S&P 500 (26-week moving averages are used). From the major bottom in the S&P 500 in early 2003, there is a clear correspondence between falling volatility and a rising stock market. The bull market was fueled by falling volatility. With the VIX approaching a likely minimum of 10, an important question is whether the stock market can push ahead without continued falling volatility.
The next chart presents a shorter term (3-year) look at the “price” action of the VIX. Key intermediate term bottoms are shown with the blue vertical lines. Since the late fall the intermediate term bottoms which are at about 10 now, occur every couple of months whereas in recent years these bottoms occurred at least 9 months apart. It looks as if the VIX may be spring loaded to rise. The 14 week RSI index sends the same message in a different manner where recent action is a series of higher lows.
For a number of reasons outside the scope of this article, volatility cannot go to zero – it must stay above a level which allows the exchanges to make money through spreads. Additionally, the fact that the “fear” component of volatility cannot go to zero results in the existence of a minimum non-zero level that the VIX can never move below. In short, spreads must always exist and fear cannot go bankrupt.
So what is the minimum level that the VIX can reach? The persistent support at near 10 suggests that this may be the minimum. This is also illustrated with the point-and-figure chart of the VIX which suggests that 9.5 is the minimum.
The corresponding index for Nasdaq 100 stocks is the VXN, which appears to have made a bottom in mid-2005. In spite of the fact that the VXN has been rising since that time (higher lows, higher highs), the Nasdaq 100 has been rising. For reasons such as this, it is probably too early to get excited about any bearish stock market implications associated with the potential for a rising VIX.
The indices were fairly neutral today, as the emerging markets ETF touched its all time high. The $HUI gold bugs index is at a level which is not a safe entry point for buyers. Since May of ’06 the best strategy was to buy weakness and sell strength. This “trend” such as it is will not last forever, though. There will come a day where it makes sense to buy strength – but this day has yet to come. Buying strength now is the stuff of the fundamentalists and guessers in my view. A decisive break of the trendline changes the big picture, I believe, as it would signal a move into the much-referenced Wave 3 of Wave III.
A closer look illustrates that the HUI is right on the threshold of the beginning of a confirmed uptrend. Again, it is at the moment of truth for gold stocks.
The S&P 500 is up trending on diminishing volume. While a correction has been due for quite awhile, the still-alive trend has been for corrections to be of minor duration and magnitude. Each and every correction since the summer rally began has been stopped quickly above the lower Bollinger band with most stopped at the 20 day moving average (shown).
Today’s VIX action shows just how strong the resistance at about 10 actually is.
Finally, a trend that is alive and well and perhaps profitable to trade upon is the trend of the price of oil divided to the 30-year bond price.
Have a great evening.
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