Don’t Chase This Rally

Get ready for another spike in volatility… soon.

The Volatility Index (VIX) is commonly referred to as Wall Street’s fear index. When the VIX is low, investors are complacent and relatively fearless. When the VIX is high, investors are scared to death and are willing to pay huge premiums to purchase put options – which provide protection for falling stock prices.

Two weeks ago, the Volatility Index was trading near 16, a relatively low reading. Investors were calm, enjoying the comfort of the one-way market we saw this year up to that point.

But, as long-time readers of Market Minute know, periods of low volatility are always followed by periods of high volatility, and vice versa. The VIX had been so low for so long it was well-overdue for a spike higher. And, last week, we got that spike.

Some folks blame it on the yen carry trade blowing up. Some folks say weak economic data showed the Fed was losing control of the economy. Some folks say increased tension in the Middle East was the culprit.

No matter the reason, investors got spooked. The VIX spiked higher – hitting as high as 65. And, stocks sold off.

Of course, this week so far is a different story. Stocks have been rallying. Investors seem happy again. And the VIX is back down to 16.

What bothers me, though, is we had seven months where the VIX was low. It seems unlikely we can balance that out with just a few days of a high VIX.

We don’t necessarily need to see several months of rising fear in the stock market. But a few weeks of it seems more appropriate than just a few days.

The 15-minute chart of the Volatility Index suggests we could see another spike in fear happen at any moment. Take a look…

This chart shows a bullish falling wedge pattern with positive divergence on the MACD and RSI momentum indicators. The VIX is approaching the apex of the wedge. So, a breakout – one way or the other – is going to happen soon.

Since the momentum indicators have been diverging from the action in the VIX – meaning they’ve been rallying while the VIX has been falling – the odds favor the VIX will break out to the upside of this pattern. And a rising VIX usually goes along with a falling stock market.

Traders should resist the urge to chase stocks higher into this week’s rally. There’s a good chance we’ll have a better opportunity to buy stocks at lower prices in the days ahead.

Best regards and good trading,

Jeff Clark
Editor, Market Minute