The Volatility Index (VIX) has generated three “buy” signals in the past three weeks.
The first two of them failed, and the third one is off to a poor start.
That’s unusual. Prior to this recent string of losers, the VIX generated seven buy signals in 2021. All of them led to sharp, short-term rallies in the stock market.
But, the last three signals haven’t worked out so well. And, that has some folks wondering if this reliable trading indicator is broken.
It’s not. But like most indicators, VIX signals work best when they’re confirmed by other trading tools – like our “crystal ball.”
Let me explain…
The VIX generates a broad stock market buy signal when it closes above its upper Bollinger Band (BB), and then drops back down and closes inside the bands. The stock market often rallies for at least a couple of weeks following these buy signals.
Here are the “buy” signals produced this year…
The blue arrows point to the seven VIX signals that worked out this year. The red arrows point to the failed signals.
What’s the difference?
Long-time readers know we refer to VIX option prices as sort of a “crystal ball” for the stock market.
Often times, when VIX call option prices are far more expensive than the puts, the VIX tends to rally – which often goes along with a falling market. And, when VIX puts are far more expensive than the calls, the VIX tends to fall – which often coincides with a stock market rally.
Last month, when we got the VIX buy signal, I explained why I wasn’t buying it.
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VIX call options were much more expensive than VIX puts. So, our crystal ball was not confirming the new “buy” signal. And, I suggested we were probably better off not trading the signal this time.
We saw another VIX buy signal near the end of November. But it too was not confirmed by our crystal ball. VIX calls were still more expensive than the puts. And, not surprisingly, that VIX buy signal failed as well.
The VIX just triggered yet another buy signal on Friday.
This time, though, the crystal ball agrees. On Friday, VIX put options were trading for about 50% more than the equivalent call options.
So, the crystal ball is predicting the VIX is more likely to be lower in the days ahead. And, a lower VIX tends to go along with a rising stock market.
Traders should be buying stocks on this new buy signal. It’s likely to be a winner.
Best regards and good trading,
In today’s mailbag, Market Minute subscribers Craig and Rob comment on Jeff’s recent essay on oil…
I trade oil futures credit spreads and yes, I agree with these oversold conditions and the OVX. Oil looks ready to move up. The big problem is this new virus, and the fear mode. I watch the MACD and I’m waiting for a crossover before entering.
I took a beating when it went down $10 in one day. If I had watched the MACD, it had crossed over on the downside a couple days before. I look forward to reading your columns. Trading isn’t easy, that’s for sure.
– Craig T.
Jeff, as you pointed out, oil is often dominated by technical trading, but also has seasonality built into the demand side. With inventories now at lower levels due to backwardation – and the refiners having sold excess inventory for tax consequences at the end of the year – oil is likely headed higher until the March contract becomes prompt for Brent oil (Jan 1-31) and WTI oil (Jan 21 – Feb 22), when refiners reduce purchases while they get their units ready for the summer spec gasoline.
– Rob W.
Thank you, as always, for your thoughtful comments. We look forward to reading them every day. Keep them coming at [email protected].