Last Friday, I suggested the market was setting up for a bounce.
But so far, that hasn’t happened.
Today, stocks are lower than where they were on Friday. Technical conditions have stretched even farther into oversold territory.
Anyone who followed my suggestion and bought stocks on Friday is underwater on that trade.
And yet, I’m sticking with it… The market is setting up for a bounce.
Not only are Friday’s technical conditions at levels that often precede strong stock market rallies… But the Volatility Index (VIX) is also on the verge of generating a buy signal.
Once it happens, it will be the fifth buy signal of 2022.
And if this one plays out like the previous four, then stocks should be higher in the weeks ahead.
Take a look at this chart of the VIX along with its Bollinger Bands (blue lines)…
Bollinger Bands illustrate the most likely trading range for a stock or an index.
Whenever the VIX trades outside of its Bollinger Bands, it indicates an extreme condition that’s likely to reverse. And those reversals create trading opportunities.
The VIX generates a stock market buy signal when it first closes above its upper Bollinger Band, and then closes back inside the bands.
That’s happened four previous times this year (blue arrows). Each time led to sharp, oversold bounces in the stock market.
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For example, the buy signal in January kicked off a one-week, 270-point rally in the S&P 500. The index rallied 10% in about three weeks following the early March buy signal.
In April, just before the Federal Open Market Committee (FOMC) meeting in early May, the VIX triggered another buy signal – which sparked another 270-point bounce in the S&P 500.
And the buy signal in mid-June preceded a rally that was strong enough to convince a lot of folks that the bear market was over. The S&P 500 gained 15% in just two months between the buy signal in June, and the peak of the bounce in mid-August.
I suspect we’re setting up for an equally strong move. It’s rare for the VIX to trade above its upper Bollinger Band for more than a few days.
As of Tuesday, the VIX has closed above its upper Bollinger Band for three straight days.
So, we’ll likely get a VIX buy signal sometime this week.
Of course, there’s no guarantee that the next VIX buy signal will lead to the same results we’ve seen from the signals earlier this year.
But most technical conditions are extremely oversold. And investor sentiment (a contrary indicator) is about as bearish as it has been in a while.
So, the stock market looks set up for at least a strong oversold bounce – if not a more sustainable multi-week rally.
The four previous buy signals this year have worked out well for traders who were willing to “buy the dip.” It’s likely this current buy signal will work out as well.
As hard as it feels to be a buyer right now, it seems to be the right move.
Best regards and good trading,
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Jeff Clark
Reader Mailbag
Will you be buying more stocks in anticipation of a market bounce?
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