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The Sleuth Back in June and early July, I devoted three separate Technical Tuesday columns to the subject of volatility. I did so because I felt that an understanding of volatility could enhance your trading and investment results. However, I was spurred to write those columns by the market sell-off that had just commenced. If you recall, when stocks began to slump, many in the financial press were suddenly throwing the word “volatility” around in their daily commentary like they really knew what they were talking about. Since I view the great majority of utterances emanating from the members of the financial fourth estate with a jaundiced eye, my first reaction was to disregard their mutterings as the latest round of mindless blather. But one thing caused me to rethink my initial reaction. You see, I was aware that the financial pundits were right this time -- volatility had increased. And the pundits were right to be talking about it. So, I decided to pen those three columns in the hopes that you could increase your knowledge of volatility and use that knowledge to your advantage when making your trading and investment decisions. ************************************** Three Events Will Wipe Out Millions of American Investors by Dec. 31, 2006 One of the world's most famous market analysts just revealed his two favorite wealth fortress investments for protecting his -- and your -- money... Read on to find out how you can get both those recommendations -- plus 12 months more of his insightful newsletter -- FREE. ************************************** Well, now that you faithful Sleuth readers are experts on the subject of volatility, I thought it would be a good idea today to look back and see whether that knowledge of volatility has been helpful in interpreting recent market conditions. Also, I thought it would be a good time to apply that knowledge of volatility to see if we can pick up any clues about the present state of affairs in the equities world. Now, I haven’t heard many of Wall Street’s purveyors of news and commentary wax eloquently on the subject of volatility lately. But that doesn’t mean we shouldn’t be mindful of it. We should. In fact, since the talk about volatility has died down, the VIX has told quite a story. Why do I say that? If you take a look at a daily chart of the VIX, you will notice that it has traded almost perfectly opposite to the S&P 500 Index over the past three months. And that’s exactly what it’s supposed to do. If you recall, I said in my July 11 Sleuth column that “[I]f you look back at the historical price action of the VIX you will see that the index has typically been negatively correlated with the S&P 500. By that I mean a rising VIX Index has generally occurred during times when the S&P 500 is falling and vice versa.” To be completely accurate, the VIX did not bottom concurrently with the top in the S&P 500 in early May. Actually, the VIX registered its low of 9.88 back on July 20, 2005. It then registered higher lows of 10.15 and 10.53 on December 16, 2005 and March 14, 2006, respectively. However, in retrospect we can see those higher lows were warning signs that a significant top in the S&P 500 lay not too far in the future. That’s particularly evident when you consider those two higher lows were made during the same time frame that the VIX put in consecutive lower highs -- in October 2005 and February 2006. Thus, as the S&P 500 was traveling upwards toward its May 8, 2006 peak of 1326.70 -- with one major pullback between August and October 2005 -- the VIX was oscillating in an ever-tighter range. That was another hint that volatility was set to increase and the trading pattern of the venerable S&P 500 was primed to undergo a sea of change. But what has transpired in both the S&P 500 and the VIX since May is much more interesting -- and potentially every bit as valuable. Let’s look at what’s taken place... ************************************** On July 6, 2002, Congress leveled the field between everyday investors and Wall Street’s inside hustlers. But on May 17, 2006, YOU gained an advantage over them all... Only 1,096 spots remain open for the one money-back-guaranteed advisory designed to cash in on this new techno-loophole -- and rake in Street-stomping gains of 68%, 85%, 133%, even 768% in just six months. Read this NOW... ************************************** The VIX notched its last minor intra-day low of 11.18 on May 5 -- just one trading day before the S&P 500 topped out. Then, as the S&P 500 turned south and dropped 6.1% over the next 12 trading days, the VIX soared, reaching an intra-day high of 19.87 on May 24 -- the same day the S&P 500 made its initial low. Incidentally, it was that spike in volatility that sparked the comments by the members of the financial chattering classes. But it didn’t stop there. After a brief respite that saw the VIX briefly poke its nose back below 14 on June 2, this important volatility gauge leaped another 71% over the next week-and-a-half, closing on June 13 at 23.81. That marked the highest level the VIX had reached since April 11, 2003. More importantly, however, that peak in the VIX occurred just one day before the S&P 500 registered an important low. Over the next few weeks, the VIX alternately put in a new post-May 5 low of 12.74 on June 30 and a subsequent swing to go up to a high of 19.58 on July 18. The June 30 VIX reading was recorded just one trading session prior to the S&P 500 registering an important high on July 3, while the July 18 reading coincided exactly with the next S&P 500 swing low. After registering that July 18 high, the VIX has once again moved lower -- coinciding with the S&P 500’s late-July/early-August rally. While I find the VIX to be a valuable tool in assessing market trends and trend changes, its accuracy over the past three months in pinpointing turning points has been downright remarkable. OK, so where are we now? As I said, the VIX’s recent decline off its July 18 high has corresponded with a rise in the S&P 500. Nevertheless, volatility -- as measured by the VIX -- remains higher than it was at its 11.18 May 5 low. Unless the VIX can take out that same low on a closing basis, volatility must be considered to be trading in an upward trend -- a negative piece of evidence concerning the short-term prospects for that widely followed stock market benchmark. Just as important, a close by the VIX above its recent high of 19.58 would likely be accompanied by lower stock prices. Not only that, but such an increase in volatility would confirm the current uptrend in the VIX -- and greatly increase the chances of the S&P 500 testing its June 14 and July 18 lows. So, if you want to know if we’re headed for more serious downside market action, or if the coast is clear, keep an eye on the VIX. It’ll keep you on track. Just ask the financial pundits. Trade well, Mark Bail
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Mark Bail has spent several years studying the financial market as well as running several options, equities, and mutual fund newsletters... <click here for full bio> |
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