Despite already losing 24% year-to-date, the S&P 500 could drop a lot further in this bear market.
That’s because traditional signs of panic-selling have been absent throughout the pullback in stocks.
But panic is how stock market bottoms form. It signals investors have given up, and the remaining weak hands have sold their shares.
Once the last bulls finally give up, the selling pressure subsides and a recovery in share prices can commence.
But so far, this selloff is missing the concrete signs that investors have thrown in the towel on this bear market…
Follow the Fear
To monitor signs of panic, I refer to Wall Street’s “fear gauge” – the CBOE Volatility Index (VIX).
The VIX measures how much traders expect the S&P 500 to swing over the near-term. A reading below 20 suggests a perceived low-risk environment, while a reading above 20 is indicative of a period of higher volatility.
As we’ve seen this year, the size of daily price swings increases when stocks are falling – hence the VIX’s fear gauge moniker.
2022 has already seen eight days with a 3% or greater decline. Only the bear market of the 2008 financial crisis and the 2020 pandemic saw a higher number in the past 70 years.
But expected volatility impacts the price of stock options, which is how traders actually spend their money.
For example, higher volatility can make the cost of options soar – especially put options which gain value when stock prices fall.
A spike in the VIX is a sign investors are panic-buying protection with put options…
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Not Enough Panic Yet
Although the VIX has moved higher this year, it hasn’t moved to the extent that historically signals a bottom.
In fact, no bear market in the past 25 years has ended without the VIX spiking to a reading of at least 45.
The chart below shows the VIX index back to 1998. Notice the surge around the early 2000’s “dot-com” bear market, 2008 financial crisis, and 2020’s plunge…
Even with each successive new low in the stock market, the VIX hasn’t been able to climb above the 36 level so far this year. That means there are two takeaways…
This bear market still has room to run on the downside until we see more signs of panic.
This panic will result in great opportunities.
Remember that when the VIX spike does come, it could signal an end to this bear market and the opportunity to make money on a recovery.
My colleague Jeff Clark had some words of wisdom this week. He stated the best trades are often the toughest ones to make.
When panic selling sets in, it’ll feel like stocks can do nothing but plunge. The hardest thing to do will be getting back in the market.
But after my trading experiences in the last three great bear markets, I can tell you it’s always darkest just before the dawn.
Analyst, Market Minute
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When do you think the stock market will finally bottom?
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