VIX Signals Move Higher on Low Volume, then Reversal

vix-aug-sep

 

Seems everyone has a comment on the market being ATH.  And bullish sentiment is very high, and with good reason- government policy promoting capital growth, a shift from old industry to more efficient industry and models, borrowing rates declining allowing for creativity in emerging markets.

Meanwhile, I take it with caution.  It’s amazing how the “new” market is opened up to so many novice traders, who can buy up stocks in the past few months and score an easy win, and suddenly they are experts.  “It’s going to go higher,” you’ll read in almost any comment section or feed on a hot stock, but no real concrete reason or strategy offered to justify it, just the fact that they hold the stock is the best indicator of bullishness.  Or foolishness.

We call this the “me-too,” phase, and it’s an area that signals a sharp reversal or correction in the market.  By this theory of trading, timing it can be very difficult, because it’s the furthest point from capitulation.  It’s almost by instinct, or more accurately, through subconscious processing of an experienced trader that one can detect this (thanks Malcom Gladwell).  It’s very hard to time this phase, but the end of this phase is marked by fear.  A realization that the market has gone up so high, it becomes harder to buy the next share.  Interestingly, this margin of utility on stock buying causes the prices of individual stocks to move up!  We say, “melt up”, to give you the antithesis feeling of a stock “melting down.”  A silent tippy-toe up the stairs, as not to wake the bears.

Yes it’s very difficult to short stocks during this period.  And you might as well just ride out your longs with a trailing stop or some rule.  But to capitalize on this emotional and psychological effect on the market, the best technical indicator out there for now seems to be the VIX (Chicago Put/Call ratio) index.  It’s not so much the movement within channels, breakouts and resistance points, and the usual classic chart tools, but rather the speed or velocity of how the chart moves.  Start by looking for “spikes” in this chart.  Spikes are relative, so I can’t simply say a move of 10% in one direction.  You need to visually see the emotion based channel over short periods of time.  If you spread out the chart to long, then the sentiment reading gets obscured.

For now, I’m pinning the market to reverse when the VIX gets under 11.50, not in a slow manner, but a sudden drop.  That number can and will be updated weekly, but it gives me an idea when to get net-short on my holdings, or when to trim longs in half.

Always stay two steps ahead of the crowd, and you’ll do fine.

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