How We Can Use the VIX to Dodge a Losing Trade

Keep an eye on the exits…

Whenever you’re trading a short-term position against a longer-term trend, you must know where the exit is.

Otherwise, you can get trapped in a losing trade.

Last Friday, I made the case that even though the intermediate- and longer-term trends for the stock market are lower, the VIX buy signal would likely generate a short-term rally. 

So far, that rally is playing out. Friday’s 64-point gain in the S&P 500 set the index well on its way to our 4100 price target.

But that rally in the stock market has also pushed the Volatility Index (VIX) down towards its lower Bollinger Band. 

In other words, the VIX is getting dangerously close to generating a broad stock market sell signal.

Take a look at the chart…

VIX sell signals are generated when the index closes below its lower Bollinger Band (BB) and then closes back inside the bands (solid blue lines).

We’re not there yet…

The VIX hasn’t closed below its lower BB. So, the earliest we could get a VIX sell signal is Thursday. The stock market can certainly work higher between now and then.

But traders need to keep an eye on the exits. It was the action in the VIX that prompted us to bet on a short-term rally, so the VIX will also tell us when it’s time to head for the exits.

If the current buy signal plays out like the three VIX buy signals last year (blue arrows), then the S&P 500 could make it up to 4100 – or even higher within the next few days.

But that’s not guaranteed.

If the VIX closes below its lower BB, then this rally could end abruptly.

And with the intermediate- and longer-term trends still bearish, traders will be better off leaving the party a little early rather than sticking around too long.

Best regards and good trading,

Jeff Clark

Reader Mailbag

What other technical indicators do you use to decipher sell signals?

Let us know your thoughts – and any questions you have – at [email protected].