Market volatility

Jeff Clark - Tue 14 Nov, 2006

...Simply put, the VIX tells you how worried investors are about the market.And as such it’s a great contrarian indicator for future market moves. Its possibly the most frightening chart in the market right now: The VIX is trading near its yearly lows, and has recently had a good go at breaking out to the upside of the bullish falling-wedge pattern, only to fall back within it...

   
 
One of my favourite contrary indicators, the Chicago
Board of Options Exchange Volatility Index (nicknamed
the VIX), measures market volatility based on options
trading, particularly the premium investors are
willing to pay to protect themselves on the downside.

If the VIX is high, it means investors are paying a lot
of money to insure a market correction won’t wipe them
out. And if the VIX is low, it means investors are calm
and unconcerned about the market’s future.

Simply put, the VIX tells you how worried investors are
about the market. And as such it’s a great contrarian
indicator for future market moves.

It’s possibly the most frightening chart in the market
right now: The VIX is trading near its yearly
lows, and has recently had a good go at breaking out to
the upside of the bullish falling-wedge pattern, only
to fall back within it.

If it has a more successful break out, then
shareholders beware...

A rising VIX is typically associated with declining
stock prices. And the current chart suggests investors
should be very cautious about committing more capital to
the stock market right now.

It’s still too early to get overly aggressive on the
short side. Bulls still have the momentum, and until
the VIX clearly breaks out – which could happen as
early as this week – it’s best not to bet too heavily
against the trend. Chasing momentum from the long side,
however, is also the wrong strategy right now.

Stocks enjoyed a fantastic month in October. The Dow,
S&P 500 and Nasdaq gained 3.4%, 3.1%, and 4.8%
respectively.

But the market is starting to look a little tired. And,
with nearly two-thirds of the S&P 500, having already
reported earnings for the quarter, there just aren’t
that many new catalysts for higher stock prices.

I’ve been sceptical of the market’s rally over the past
month, and perhaps a little too cautious...

But with the semiconductor stocks continuing to lag
behind the overall market, and with the VIX on the
verge of breaking out to the upside, a little bit of
scepticism is probably a good thing.

In the last four months, whenever the VIX peaked and
everyone was worried about the market’s future, the S&P
500 rose 3% soon after. It happened in a three-week
market rally following the VIX’s spike on June 13, and
again when the VIX peaked on July 17.

Currently, the VIX is falling back to its historic low
levels...and that’s what worries me. Looking over the
VIX’s two-year chart, virtually every time the index
fell to the 10-11 trading range, the market stumbled.

Be careful.


Successful investing,

Jeff Clark
For Profit Watch