A sell signal is now unavoidable.

The Volatility Index (VIX) has closed below its lower Bollinger Band for two straight days. When it closes back inside the bands, it will generate a broad stock market sell signal. And as I mentioned on Monday, this signal could be a big one.

Monday’s essay prompted two common questions from concerned readers… When will it happen? And, how bad could it get?

The “when” is easy to answer… Soon.

The VIX has been below its lower Bollinger Band (BB) for two days in a row. It’s rare for the VIX to close below the band for three straight days – though I have seen it happen. And I can only recall one time when the VIX spent four days below its lower BB. I’ve never seen it stay there for five straight days.

So, unless we’re going to make history, the VIX should generate a sell signal today or tomorrow.

As for “how bad can it get”… well… let’s look at the chart of the S&P 500…

This chart is tracing out a bearish rising wedge pattern. This happens when a chart makes higher highs and higher lows, but the distance between the highs and lows gets smaller. Most of the time, this pattern breaks to the downside in a quick, sharp move.

The S&P 500 closed yesterday right on the resistance line of the wedge. There is room for the S&P to work slightly higher inside the wedge before reaching the apex – where it will have to break out of the pattern one way or the other. So, the index could chop back and forth for a couple of sessions before we get a larger move. But, we should see a breakout – either up or down – by Friday at the latest.

And since the VIX is on the verge of generating a sell signal, I think the odds favor a move to the downside.

If and when that happens, the first downside target is near 2780. That would be a “healthy,” 3% correction from current levels. While that might shake up some of the recently converted bulls who have chased stock prices higher this week, it wouldn’t do too much damage.

A more significant decline is possible, though.

If the S&P 500 doesn’t hold support in the 2775-2780 area, then the next support level is all the way down near 2700. A decline to that level would be more than a 5% correction. It would wipe out all of the gains from July. And it would shake the confidence of most investors.

For the moment, I think we’re more likely to see a smaller correction play out. Many of the daily technical indicators are overbought. But, they’re not at extreme enough levels to fuel a 5% decline from here.

So, traders who choose to bet on some downside action might look at the 2780 level as a good target for the impending VIX sell signal.

Best regards and good trading,

Jeff Clark

Reader Mailbag

Today, readers respond to yesterday’s Market Minute, “A Biblical Trading Lesson”…

That’s an awesome truth!

– Jeff

I want to thank you for today’s Market Minute, although I am not a subscriber of your paid service. This a piece of information that should be put in the “Ten Commandments” of the investing or trading world. Keep up the good work and maybe somewhere in the future I will have the means and the understanding of options to join the ranks of your service.

– Dan

Thank you for such a beautiful story. As traders, we all have experienced these emotions. Also, in life, it is always good to look forward. Not to cry over spilled milk. Thank you.

– Pramila

Jeff, you could not be more correct in the analysis of trading options! I have been doing this since the mid ‘90s. Have made small fortunes and lost small fortunes. There is too much work to be done getting on with the next trade to look back. As a woman trader jumping onto this crazy merry-go-round, I was fortunate in the beginning to have a few remarkable male mentors who told me to never, “woulda-shoulda-coulda” an option trade; ever. And salt is truly the worst poison.

Thank you for all the wise guidance; it is much appreciated.

– Leslie

Thank you, as always, for your kind and thoughtful letters. Keep them coming right here.