TradingMarkets Monday Stock Movers: VIX Edition
Stocks are responding to three consecutive days worth of gains in the Dow industrials and S&P 500 with pullbacks to start off the trading week leading into Labor Day Weekend.
How do you know that you are looking at a market that is more neutral than anything else? How about finding absolutely no candidates in our TradingMarkets Stock Indicators? Consecutive down or up days? Empty. Stocks with 2-period RSIs of more than 98 or less than 2? Nothing. Gaps – or laps – of 5-10% or more. The coast is clear.
Is the market as neutral as our TradingMarkets Stock Indicators are suggesting? With very few stocks with either our highest (10) or lowest (1) Short Term PowerRatings, one tool we can turn to in order to gain a better understanding of the market’s condition is the VIX or CBOE Volatility Index.
TradingMarkets co-founder and CEO Larry Connors has done some of the most pioneering work on the CBOE Volatility Index. One of his key insights is that absolute level of the VIX is less important that the relationship of the VIX to itself. He wrote, in his book, How Markets Really Work:
“If there is one truism that we’ve found, it is the fact that static numbers do not work when it comes to the VIX.”
What did Larry and his research team find out about the VIX? By way of summary, he noted:
“… the VIX acts as a barometer to guide you as to how aggressive you should be on the long side, short side, locking in long gains and locking in short gains. As the VIX moves further above its moving average, the likelihood of a market rally increases. The opposite is true when it comes further below its 10-period moving average.”
How can we use this knowledge to help us as traders today and tomorrow?
As the chart above shows, the VIX was particularly extended below its 10-day moving average (in blue) as of Friday’s close. In fact, as of the Friday close, the VIX’s 10-day moving average stood at 20.41, while the VIX itself closed at 18.81. This means that the VIX has entered that 5-10% “stretch” range after which market reversals have often occurred. Because this “stretch” was to the downside, we are seeing growing complacency in the market. As such, we should expect short term market softness – such as we are seeing Monday morning.
Going forward, we will continue to look at both our TradingMarkets Stock Market Indicators as well as our Short Term PowerRatings for the most exacting clues of where stocks are headed next. But when those two sources prove inconclusive, we are confident that the historical analysis of the VIX will prove to be an additional source of market intelligence to guide our trading in the short term.
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David Penn is Editor-in-Chief at TradingMarkets.com.