It has been more than year since the VIX maintained a lower reading. The trouble started during the Santa Claus rally of 2011. From Dec. 5 through Dec. 19, 2011, the VIX dropped while the S&P 500 peaked around 1267 then fell to 1202. All calculations aside, that’s when fear left the market, which was OK because the VIX was in the high 20s. Since the latter part of 2012, though, the market has not been able to make good progress.
Last year was dominated by the lower VIX reading. Indeed, there was one key sequence when it was repeatedly reported the VIX was no longer relevant because pundits were expecting a market turn on the low readings. Consequently, the market peaked and corrected approximately a week later. We should have learned from the Internet bear and real estate bubble that sooner or later prices revert to the mean, and when sentiment seems to suggest a new normal, that’s precisely the time risk is getting high and a turn is imminent. As we’ve seen, the VIX follows a 20-plus year trend. Is it realistic to think the market is going to adopt a new normal?
On a day-to-day basis, it’s important to keep track of how much fear comes into the market based on the current sequence. With respect to the VIX, a quick look will allow you to to gauge your fellow traders and determine the potential of a move. However, one of the most important lessons is one of the hardest to follow with respect to human nature. A trader positioned late in the move should use an extreme VIX reading as a warning sign that an important turn could be imminent.
Jeff Greenblatt is the author of “Breakthrough Strategies for Predicting Any Market,” editor of the “Fibonacci Forecaster,” director of Lucas Wave International LLC and has been a private trader for the past eight years.