| The
VIX measures fear and optimism as measured by OEX
options activity. When large numbers of traders
become fearful, the VIX reading rises, and when complacency
develops, the VIX reading falls. Since the
majority of put to call buyers are usually wrong about
the future direction of the market it's usually a fairly
reliable Contrarian Indicator. When
the VIX exhibits "High" readings it means the
market is becoming oversold (excess of bearishness)
and when there are "Low" VIX readings the market
is becoming overbought (excess of bullishness).
So when the VIX is at extremes it usually gives a strong
signal of a nearing Bottom or Top depending on the current
market environment.
If we look at a chart of
the S&P 500 versus the VIX over the past four years
there are several examples of extreme readings in the
VIX leading to a nearing bottom or top in the S&P
500. First lets look at what has occurred
when the VIX has dropped to rather low levels.
Some examples include last Spring (point A), the
Summer of 2000 (point B), the Summer of
1999 (point C) and even further back in the Summer of
1998 (point D). In each of these examples
the VIX dropped to a value of 20 or below as the S&P
500 was nearing a top which was then followed by a sell
off. You may notice as well that from the middle
of December 2001 into January of 2002 the VIX has been
hovering at fairly low levels (point E) which may explain
why the market has been under some selling pressure
recently as too much bullishness has developed in the
investment community.
Click on the image to enlarge.
Next lets
look at what has occurred when the VIX has spiked up
strongly and reached extreme levels to the upside instead.
As shown below strong spikes upward in the VIX usually
has led to some type of bottom in the S&P 500 followed
by a strong reversal to the upside. Some examples
include this past Fall (point F), in the early Spring
of 2001 (point G), Spring of 2000 (point H), Fall
of 1999 (point I) and in the Fall of 1998 (point J).
Click on the image to enlarge.
This doesn't
mean the VIX is always perfect however most of the time
it's a fairly reliable Contrarian Indicator especially
after the market has undergone a substantial move to
either the downside or upside. As an investor
watching the VIX carefully can help you determine when
the market may be nearing a Bottom or Top and when to
get back into or out of the stock market.
|
New
Trading Ideas