This Signal is Nonsensical

Keep an eye on the Volatility Index (VIX) this week. It’s on the verge of generating a broad stock market buy signal.

Maybe that doesn’t make any sense.

After all, the S&P 500 closed Friday at its lowest level in three weeks.

The index is trading below its 9- and 20-day exponential moving average lines – which will provide resistance on any bounce attempts. And, we’ve entered the seasonally weak period between August and October.

So, it seems a bit nonsensical to be looking for a buy signal. And yet, here we are.

Take a look at this chart of the VIX as of Friday’s close…

The VIX generates a buy signal when it first closes above its upper Bollinger Band, and then closes back inside the bands. The VIX has given us two buy signals so far in 2023 (the blue arrows).

It’s on the verge of giving us a third.

As of Friday, the VIX had closed above its upper Bollinger Band for three straight days. Under normal market conditions, three days is just about the most time the VIX will stray outside of its bands.

In extreme conditions, I’ve seen the trend last for as much as six days. But the recent market action doesn’t feel like extreme conditions.

So, there’s a good chance we’ll get a VIX buy signal early this week.

Here’s how the S&P 500 performed following the two previous buy signals this year…

In both cases so far this year, the S&P 500 rallied immediately following the VIX buy signal.

The S&P 500 gained over 200 points in less than three weeks following the VIX buy signal in March. It popped 300 points higher in about three weeks in June.

We’re now in position for another VIX buy signal at any moment.

If the bounce follows the same script as the two previous buy signals this year, then the S&P 500 could be trading above 4600 by the end of the month.

That’s not a guarantee, of course. Technical conditions remain bearish for the intermediate- and long-term timeframes. And, anything can happen in the short-term.

But, VIX buy signals have a strong history of pinpointing stock market rallies.

So even with the bearish backdrop of the August to October timeframe, it looks like the stock market is set up for a decent short-term bounce.

Best regards and good trading,

Jeff Clark

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