I’m not happy with the stock market.

I should be. The market seems to be doing everything I wanted it to do. We got a Volatility Index buy signal last week. And the market has responded well to that signal. The S&P 500 is up 40 points in just the past seven days.

That looks like a good start to the summertime rally I’ve been expecting. But there’s a problem…

It’s a case of “too much, too soon.” Too many people have turned too bullish, too fast. It’s as though, all of a sudden, everyone is calling for a summertime rally to new highs in the stock market.

I appreciate the financial television talking heads finally coming around to agree with my opinion. But I’ve also played this game long enough to know that when everyone else agrees with me, I’m probably wrong.

Over the past week, we’ve seen a dramatic change in circumstance. The broad stock market has gone from oversold to overbought. And the Volatility Index (VIX) has gone from trading above its upper Bollinger Band to approaching its lower Bollinger Band.

What’s worse is the chart of the VIX now looks poised to pop higher once again. Take a look…

The indicator at the bottom of the chart is the MACD histogram.

Longtime readers know we like to use the MACD momentum indicator to help identify potential reversals in a trend – either from a downtrend to an uptrend or from an uptrend to a downtrend. The MACD indicator will often reverse before the price of a stock reverses.

But as I explained a few weeks ago, that’s not always true in the case of the VIX. The MACD indicator for the VIX tends to move at the same time as the price. So, there’s not much predictive value in following the MACD indicator on the VIX.

There is value, however, in following the MACD histogram.

Without getting too complicated, the MACD histogram helps to identify a potential reversal in the MACD momentum indicator. In other words, the histogram is an indicator of an indicator.

And in the case of the VIX, the MACD histogram has a pretty good track record for identifying reversals.

Look back at the chart above for some examples. While the VIX was falling last September, the MACD histogram was rising. Three weeks later, the VIX was 18% higher.

In March, while the VIX dropped to a lower low, the MACD histogram rallied. This “positive divergence” preceded a 71% spike in the VIX two weeks later.

In mid-May, the VIX dropped to a lower low. Meanwhile, the MACD histogram was rising. That was a sign we were about to get a larger move higher in volatility.

We did. The VIX popped 28%.

Now we’re looking at a similar situation. The VIX closed yesterday below 12. That’s its lowest closing level since late January.

Meanwhile, the MACD histogram has made another “higher low.” This is the sort of positive divergence that often occurs just before a sharp spike higher in the VIX.

Sharp spikes higher in the VIX often coincide with sharp moves lower in the broad stock market. So, I think most traders should be cautious right here.

The market is acting strong. But its actions could change quickly.

Best regards and good trading,

Jeff Clark

Reader Mailbag

Today, a Delta Report subscriber relates to Jeff’s approach…

Hi Jeff, I joined your service a couple of months ago.  I’ve been an active trader since 2007.  I really enjoy your perspective and instincts.

Like you, I like looking for reversion-to-the-mean opportunities. I created my own search to look for divergent trades like [two of your recent ones] (both of which I’m in).  Looking forward to the trade you may be sharing tomorrow. Personally, I like the way Philip Morris (PM) looks. All the best.

– Charles

And a new Market Minute reader celebrates their subscription…

Hi Jeff, I recently became a subscriber to your Market Minute, and I want to thank you for the same, as it adds an additional layer of valuable information and data for my own analysis.

– Ketan

Thank you, as always, for your thoughtful insights. Keep them coming right here.