This Indicator Is Up 30%…So What Does That Tell Us?
The
market has continued to sell off,
punishing nearly all sectors. Breadth has been decidedly negative. Volume has
been decidedly negative. And yes, price has been decidedly negative. Since my
report last
Wednesday we have seen a huge spike in the VIX. In fact, last Thursday the
VIX closed over 30% higher than its 10-day moving average. (Over 25% higher today.)
As most TradingMarkets members know,
high VIX readings relative to their 10-day moving averages tend to lead to a
bounce in the market. Larry
Connors defines a high reading as 10% or more above the 10-day moving average
for several of his CVR strategies. So when I noticed 30%, that really caught
my eye.
I decided to look back and find other
times when the VIX spiked 30% or more above its 10-day moving average. I wondered
if such an extreme number had any special significance. As I suspected, this
phenomenon is quite rare. The last 5 occurrences I was able to find were:
January 27, 2003
July 24, 2002
June 2002 (a few times between the 4th and 14th)
February 23, 2001
October 13, 2000
Most traders will remember the huge
market reversal that took place in July of 2002. What is interesting though
is that July 2002 was the exception here. All of the other instances were followed
by a weak bounce in the market and then another sharp selloff. In October of
2000 this selloff was very brief and the market did move higher for a while
following it. In the other three instances the ensuing selloff was much more
significant than the bounce.
By no means is this observation statistically
significant. I’ve only looked at 5 past occurrences (all of which occurred
in a bear market environment). I therefore wouldn’t make any big bets
based on this “researchâ€.
I would be cognizant of the possibility
that even though we’ve seen a sharp selloff already, the worst may still
be yet to come. You should also note that if this selloff does persist, it might
not offer any easy opportunities to get short. The stronger the trend, the weaker
the pullbacks. An example of this would be from the beginning of December 2003
to the middle of January 2004. The market during that time trended steadily
higher. Those who waited for a pullback of three days or more to enter never
got it.
If you are able to find opportunities
in individual issues with good risk/reward ratios and tight stops, I wouldn’t
hesitate to take them. I would take quick profits on a part of any new short
position and move stops to breakeven as soon as possible. The market will bounce
again, and short-covering rallies can be fierce so caution is definitely warranted.
Still, I would definitely keep an eye out for any short opportunities, as down
appears to be the most likely direction for a while.
Best of luck with your trading,
Rob Hanna
robhanna@rcn.com