The one thing we try to focus on in our blog is a study of the VIX. We’ve done several post on what the VIX is so we won’t go into that here.
The VIX can be an excellent tool for any trader as it is, in my opinion, one of the best indicators for the market. Unfortunately the VIX is not as cut and dry as most indicators. When we look at the McClellan Oscillator or Stochastics we can look at the indicator and see if it is over a certain value then it is overbought or if it is under a certain value it is oversold. That is a pretty cut and dry approach.
It is not that simple when we look at the VIX. We cannot see overbought/oversold or any other type of indication from simply looking at the number. The VIX is not a 1-dimensional indicator that we can simply look at and be done with. We must dive deeper. The VIX is a complicated machine that has a lot of extra parts. When getting a read on the VIX we need to look at the futures, contango/backwardation, skew, S&P 500 strike implied volatility, and relative nature to the S&P 500.
For now we will just look at the VIX as it is relative to the S&P 500. When we see a -1% drop in the S&P 500 like we saw last week we immediately expect a big up move in the VIX. Normally, but not always, we will see a +7% move in the VIX for every -1% move in the S&P 500. So we got our big move in the S&P 500 and the VIX. However, on the next day we again saw a big -1% move in the S&P 500 but we did not get the same move in the VIX.
Let’s look at a chart of the VIX:
Notice the last two days on the chart we see big up moves in the VIX.
Now look at a chart on the S&P 500:
Again look at the last two days on the chart. As you can see by the last two candles we kept moving lower and lower in the market but we were not getting the same type of reaction out of the VIX. We would expect bigger moves out of the VIX to keep up with the market. When the correlation breaks between the S&P 500 and VIX we must take notice. It doesn’t matter what number the VIX is at >20 or
Even though the sell off was hurting the market there was no fear left. That is when we decided the market was going to bounce. We started to shed our short positions and look for longs to take overnight. Two days later we get a +1.5% bounce and then a +2% bounce out of the markets.
Studying the VIX can help you tell when the markets are fearful or not. It will help you stay in tune with the markets themselves.
