Volatility got crushed last week.

The Volatility Index (VIX) – often seen as a measure of fear in the market – dropped 14%. It closed Friday at 12.65 – its lowest level since the correction started in late January. In other words, investors are now about as complacent as they were just before the S&P 500 peaked above 2870.

From a contrarian point of view, this recent and sudden lack of fear among investors is a good reason to be fearful.

Since early this year, I’ve been arguing that the stock market has entered a new era of heightened volatility. The period of low volatility that ran all the way through 2017 is over. The VIX is likely to remain elevated all through 2018.

Even with last week’s decline, the VIX is still up more than 33% so far in 2018. And by the look of the following chart, I think we’re setting up for another sudden, sharp spike…

The VIX closed Friday below its lower Bollinger Band for the third straight day. That is an extremely unusual occurrence.

Think about this… Bollinger Bands represent the most probable trading range for a stock or an index. So, when the VIX trades outside of its Bollinger Bands, it’s doing something “improbable.” And last week, it did the “improbable” for three straight days.

Notice also at the bottom of the chart the MACD and RSI technical indicators are as oversold as they’ve been in a year. So, the proverbial rubber band for the VIX is now quite stretched to the downside. Volatility is poised to snap back.

As I mentioned last Thursday, and as longtime readers know, when the VIX closes below its lower Bollinger Band and then rallies to close back inside the bands, it generates a broad stock market sell signal.

The VIX has now traded below its lower BB for three straight days. That’s something that doesn’t happen often. It’s quite likely the VIX will close inside its Bollinger Bands either today or tomorrow. And, that will trigger a broad stock market sell signal.

S&P 500 futures are sharply higher on Sunday night. If that holds until the opening on Monday then stocks are going to pop higher and the VIX is likely to drop even farther into oversold territory.

But remember, the rubber band is already stretched quite far. It may stretch even more at the opening of the stock market today. But it is primed to snap back.

For my money, I’m betting on an increase in volatility this week. And, since a rising VIX often occurs during a falling stock market, I’m looking to sell stocks into strength this week.

Best regards and good trading,

Jeff Clark

P.S. There’s only one indicator I trust during times of heightened volatility… the V-Line.

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Reader Mailbag

Today, a question about how to read a key technical indicator. But first…

Hi Jeff. Thanks for all the great posts in the blog lately, and especially for the last one today with the 15-min chart and reminder of what happened on April 17 [Delta Report subscribers can find it here]. I happen to agree with your view, and purchased a small position on your SPY put recommendation this afternoon.

I love your TA and indicators you use and your ability to see what most others don’t. That is what gives you (and us) the edge, and a higher probability of successful trades in this crazy market environment. I am so thankful for and love your passion and dedication to your work and to your subscribers! Please don’t ever quit doing what you do!

– Ryan

Thanks Jeff! GLW out @ $1.00. +$355, +34% in two and a half days.

– Kevin

Hi Jeff I’ve been using your various services – first with your previous publisher and now at Delta Report where I am a lifetime subscriber. May you live long and prosper. When you refer to the VIX chart and Bollinger Bands, what time frame do you use as the Bands are different for the time frame used?

Keep up the good work. I’ve been trading options since 1978 and once professionally for a firm trading desk. It’s harder than it looks but you make it look easy.

– Tom

Jeff: Hi Tom, thanks for the question. I only look at Bollinger Bands on the daily chart of the VIX – not for any other time frame. I just haven’t found buy and sell signals on intraday VIX charts to be consistent enough on which to trade. The daily chart, on the other hand, gives very consistent signals.

When using Bollinger Bands on the daily chart, be sure to set the parameters at 20 and 2. That’s the default parameter on most charting programs.

Thank you, as always, for your thoughtful letters. Keep them coming right here.