What Does the VIX Say?

07/24/2014 6:00 am EST

Focus: STRATEGIES

Gregory Harmon, CMT

Founder and President, Dragonfly Capital Management

Traders and investors seem to use the VIX in all sorts of ways, but technician Greg Harmon of Dragonfly Capital likes to look at actual price and index action to try to seek an edge.

Traders and investors use the Volatility Index, (VIX), in many ways. Some look at low levels and expect a mean reversion, a pure volatility play. Others assign a relationship to the underlying S&P, and options contracts that are used to determine it. Still others see it as a pure barometer of risk in the market place and determine which side of the market to be on based on its level.

I am an observer. A Market Technician, so I like to look at actual price and index action and seek an edge. Sometimes this comes in a relationship between assets or asset classes, or it may be a pattern that has proven itself over time to repeat. My eyes see both of these exist in the VIX.

chart
Click to Enlarge

The chart above holds all the information necessary to be on the right side of the market the last 18 months if you are a VIX follower. It shows 11 instances where the action in the VIX has preceded a new all-time high in the S&P 500 (SPX). This is what I see. First, the VIX spikes over all of the Simple Moving Averages (20, 50, 100, and 200 day SMAs), but remains benign, under 25. Then the VIX falls back under the SMAs. Shortly there after, the MAC-D gives a sell signal as it crosses down. The last 11 times this has happened, the S&P 500 has gone on to make a new all-time high as noted in the bottom panel.

It turns out this VIX signal may be talking again. It spiked over the SMAs last week and is moving back lower. It still has the 20- and 50-day SMAs to cross below, and then the MAC-D cross down. But with the S&P 500 near all-time highs already, it seems likely to make another new high, whether the signal rings an alarm the twelfth time or not.

By Greg Harmon of Dragonfly Capital

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