Life’s been great lately for stock market investors.
Since October 27, all the major stock market averages have moved sharply higher.
The Dow Jones Industrial Average has rallied nearly 6%. The S&P 500 has gained over 7.6%. And the Nasdaq has been up nearly 11%.
And while we will get further upside, this mini melt-up has to take a breather first.
My colleague Brad Hoppmann is one of the best technical analysts I know. He uses a method called predictive analytics to forecast market moves.
Brad’s recently cautioned readers about chasing stocks higher in the short term. My own analysis agrees with him.
Today we’ll be taking a closer look at the Volatility Index (VIX). The VIX – as you might already know – is the market’s expectation of 30-day volatility.
Put simply, when the VIX is trading at elevated levels, the market is expecting a lot of volatility.
On the other hand, when the VIX is trading lower, the market is getting complacent.
The VIX peaked on October 23. It’s been trending lower ever since. Of course, that makes sense. It’s exactly what we want to see when the markets are rising.
But right now, the VIX is starting to fall into dangerous territory.
Take a look…
There’s a value range in the VIX from about 11 to 13.50 that has historically resulted in some fierce market selloffs. I refer to this as the “danger zone.” As a point of reference, the VIX is currently trading at around 14.20. Not too far away from the danger zone.
The last time the VIX fell into this danger zone was on September 14. That coincided with the Nasdaq and the S&P 500 both selling off for over 9%. And the time before that was on July 27. That marked a quick sell-off in the S&P 500 of 5.9% in just 17 days.
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You can see just how consistent this zone has been over the last several years. Nearly every time the VIX has hit the danger zone (red arrows), we saw a spike in volatility and a drop in the market.
We’re rapidly approaching the zone now. So, it’s time to be cautious with the stock market right now.
If you’ve gotten into a handful of great trades over the last couple of weeks, then it’s time to consider taking profits. At the very least, using a trailing stop loss is likely a very good idea.
And if you’ve still got some cash you’re waiting to put to work, it’s better to wait for the next pullback. It’s likely going to be a great buying opportunity for the next run higher.
Are you taking profits on any positions?
Let us know your thoughts – and any questions you have – at [email protected].