The Volatility Index (VIX) just triggered its second buy signal of 2018.

VIX buy signals occur when the index closes above its upper Bollinger Band – indicating an extreme overbought condition in volatility. It then closes back inside the bands – indicating a return to more neutral levels of volatility.

The first buy signal of the year triggered on January 19. The S&P 500 rallied 70 points in five days following that signal. So, following the signal definitely paid off – as long as you didn’t overstay the trade.

On Monday, I warned that the market’s action was setting up a parabolic move on the S&P 500 chart. The index has since broken down from that pattern. And, at the low of the day yesterday, the S&P had given back all of last week’s gains.

Going out a few weeks, I expect stock prices will be lower. Parabolic moves usually end by giving up all of their gains. So, the odds look pretty good to me that the S&P will trade back down towards 2700 over the next several weeks.

For the next few days, though, the market looks higher.

The VIX closed above its upper Bollinger Band on Monday. It closed back inside the bands on Wednesday. So, we have a new VIX buy signal.

Here’s how the S&P has traded following the eight previous buy signals…

In every case, the VIX buy signal marked at least a short-term low for the broad stock market. There’s no reason to think the current signal won’t work out the same way.

Even though I’m looking for lower stock prices over the next month or two, I’m not yet ready to load my portfolio with aggressive short positions. The new VIX buy signal suggests we’ll have better prices at which to short stocks over the next week or so.

Best regards and good trading,

Jeff Clark

Reader Mailbag

Today, readers’ thoughts on the potential bond breakout, the gold market, and more.

But first, a question…

Good afternoon, Jeff. I have a question regarding Bollinger Bands.

I have seen you write recently that when a price closes above the upper Bollinger Band, and then closes back inside the bands within the next few days, that represents a buying signal. Can I ask why? Can I ask what your thinking is that closing above the bands (and therefore the standard deviation) and then closing back within the bands sets up a long-side entry point?

– Michael L.

 

Jeff: Hi Michael, thanks for writing in. I hope today’s essay answers your question.

But, just to elaborate…

When the VIX closes above its upper BB, the broad stock market is usually in extremely oversold territory. But that action by itself doesn’t mean we should step up and buy. Oversold conditions can get more oversold.

The VIX can continue to press higher above its upper BB. The close above the BB simply alerts us to be on the lookout for a potential reversal.

When the VIX closes back inside its BBs, it tells us the proverbial rubber band is ready to snap back. That’s when traders can be confident the market is poised to reverse.

VIX trading signals are not 100% accurate. Nothing is ever guaranteed. But our track record following VIX signals is quite good – which is why I write about them whenever they occur.

 

And now, your responses to this week in the Market Minute…

I bailed GDX due to daily short selling, MACD diverging, and lower low. I will watch your analysis closely. I like what I see.

– Bernard B.

 

“Breakout”? Not really. This is classic chart tea leaf reading with lines drawn in to suit the desired conclusion.

The highs at the end of 1994, at the end of 1999, and in summer 2006 could at the time equally have been seen as a “breakout”, only for the downtrend to resume some time later. There is zero predictive value in this chart.

– Reinhard S.

 

Fed will raise three times this year. Then panic with inverted yield curve and start lowering rates quickly next year to avoid recession.

Equities will have big correction this year and then recover some next year. We’ve seen this movie before.

– Patrick V.

 

There are trades out there. It is just a matter of what is most comfortable for you as a trader.

Some are not your thing, but they are out there to be traded. It appears your trading world is vastly different and there’s absolutely nothing wrong with that. Point being, there are MANY trades out there that are passed by, I guess.

Think some have questioned that via emails to you in the past. I am not.

– Jeff W.

Way to kick the feedback up a notch, readers. Thank you.

And as always, send all your stories, questions, and comments right here.