For only the second time this year, the Volatility Index (VIX) is about to trigger a broad stock market sell signal.
The Volatility Index (VIX) is commonly referred to as Wall Street’s fear gauge. The VIX rises as investors grow fearful. It falls when investors are complacent.
Extreme moves in the VIX are excellent contrary indicators. As traders, we look to buy stocks when the VIX makes an extreme move to the upside, and we look to sell stocks when the VIX makes an extreme move lower.
Bollinger Bands measure the most probable trading range for a stock or index. Whenever a chart moves outside of its Bollinger Bands, it indicates an extreme condition – either extremely overbought or extremely oversold. Since the VIX is a contrary indicator, it’s best to buy stocks when the VIX is extremely overbought. It’s best to sell stocks when the VIX is extremely oversold.
Longtime readers know we use the VIX to generate trading signals. Buy signals occur when the VIX closes above its upper Bollinger Band and then closes back inside the bands. We get sell signals when the VIX closes below the lower Bollinger Band and then closes back inside the bands.
The VIX generated a sell signal back in July, when it closed below its lower Bollinger Band for three straight days, and then rallied back inside the bands. It took a while for the selling pressure to kick into gear. Eventually, though, the S&P 500 lost about 150 points before the VIX generated a new buy signal.
Here’s how the action looked on the chart…
The stock market has been strong so far this week – which is typical action during the week of Thanksgiving. And that strength in the market has caused volatility to shrink even more from its already depressed level. The VIX closed below its lower Bollinger Band on Monday. It stayed below the band on Tuesday as well.
But, once the VIX closes back inside its Bollinger Bands, we’ll have a broad stock market sell signal. It’ll be only the second sell signal of 2019. But, based on how the first one played out, traders ought to be cautious.
If you’re looking to put money to work in anticipation of a year-end stock market rally, you may have a better chance to do so in a couple of weeks.
Best regards and good trading,
P.S. If you’re a long-term investor, you might not know how to react to a market drawdown. And if you ask me, that skill will be crucial in the months ahead.
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Are you hoping for a year-end market rally? Or are you betting on a decline before the year’s over?
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