Last week, I noted that the VIX had been moving up along with gold. Both of these vehicles can be considered “risk off” vehicles – a sign that investors are running for the hills. Here is the blog.
The VIX is a good vehicle for spotting overbought and oversold markets. As I noted on last week’s blog, a high VIX is a decent sign that markets are oversold- and that condition doesn’t last long. Meanwhile, a low VIX can be a sign of overbought markets, but that condition can last for many months. So you really need to keep an eye on other indicators before jumping to conclusions regarding a buy or sell signal coming from the VIX.
I’ve recently experimented with refining the signals coming from the VIX indicator. Below is a chart tying the short termed (3 month contracts) Volatility index ($VXV-US, red line) to the diversified VIX index ($VIX, black line). On the bottom panel of the chart you will see a relative strength indicator—this illustrates how the short termed VIX compares in performance to the broader VIX index. It seems that when the performance of the short contracts outperform the broad index by 10% or more, the VIX makes a better case of putting in a bottom. You can see this via my vertical lines that run through those incidents, and note how the S&P500 (green line, second from bottom) did tend to put in a bottom somewhere near those points. This helps refine an entry point when you are watching the VIX trade at high levels. Click on the chart for greater detail.
I drew another horizontal line on the bottom pane to represent an underperformance by the short VIX indicator of -30% or greater. This seems to help spot neartermed tops on the markets – another tool to help us refine our exit timing. The underperformance period is still less “spiky” than the outperformance periods, but it does tend to shorten the signals.
As always, I encourage you to view any indicator in conjunction with others. If you read my book Sideways, you will see that I tend to endorse using indicators the VIX, or momentum oscillators, breadth or even fundamental valuation as a second step after trend analysis. The ultimate tool for our decisions as technical analysts is trend analysis. Trend is all about rising or declining peaks and troughs – aided by a longer termed moving average such as the 200 day SMA. All other tools, including the VIX, are to be used in addition to trend analysis.
That being said, it does look like the VIX and the VXV are in a rather neutral spot again, having come off of a raging overbought level that began in January. As such, no clear overbought or oversold indications can be identified from the volatility indicators at this time
I seem to recall someone plotting a ratio of these 2 instruments with interesting results.
That was sentimentrader–they do a ratio. I did a relative strength study–same concept more or less.
I didn’t see a spot on their site where they regularly report their ratio, so I did my own study of the comparative RS that I can look at as I wish.
The last time they spoke of it a week or so ago, they saw it was “overdone” meaning too much pessimism–my RS line isn’t into that level as you can see on the chart–I show a neutral level, but it depends on how you want to define the oversold level.
With the sudden drop in oil pricing today Wed Apr 19, it makes me question where does the current trend look now. We were expecting it to go near $60 in the near to mid term. Maybe this is simply a buying opportunity for those who missed the last bounce upwards.
What are your thoughts Keith?
Great idea for a blog post–watch for a post today (Thursday April 20th) on the subject!