The Volatility Index (VIX) is on the verge of generating another stock market sell signal.
Regular readers know sell signals occur when the VIX closes below its lower Bollinger Band and then rallies to close back inside the bands. After going through all of 2017 without generating even one sell signal, the VIX is about to give us the third sell signal for 2018.
Take a look…
On Friday, the VIX closed right on its lower Bollinger Band. It won’t take much of a decline from here for the VIX to close below the band. Then we’ll get a sell signal on the next pop higher.
We’ve had two VIX sell signals so far this year (the red circles on the chart). The S&P 500 lost over 100 points in just one week following the first sell signal in mid-April. The second sell signal in mid-May led to a 60-point drop in the index in two weeks. The next sell signal, when it occurs, could be a whopper.
Let me explain…
Take another look at the above chart. Notice how the Bollinger Bands are contracting and pinching together. In fact, the Bollinger Band width is as narrow as it’s been since about mid-January. This means energy is building for a big move in the VIX.
Remember… periods of low volatility are always followed by periods of high volatility – and vice versa. We don’t need to look back any farther than late January for proof of that.
I’m not suggesting the VIX will spike as high as it did back then, or that the market will sell off as hard. But energy is building for a big move in volatility. The VIX is on the verge of generating a broad stock market sell signal. And we’re heading into the stock market’s seasonally weak period of August and September.
This is probably not the time to be adding aggressively to the long side. Most traders should be cautious. And aggressive traders should consider adding some short exposure.
Best regards and good trading,
Jeff Clark
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