Since the U.S. stock market still appears to be trying to make up its mind which way things will go from here, this appears to be as good a time as any to expand on the idea of using the VIX to “buy the freaking dips.”
So says Dave Moenning (www.benzinga.com) in edited excerpts from his original article* entitled A Flashing Buy Signal from VIX?.
[The following is presented by Lorimer Wilson, editor of www.FinancialArticleSummariesToday.com and www.munKNEE.com and may have been edited ([ ]), abridged (…) and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.]
Moenning goes on to say in further edited excerpts:
A simple (okay, really simple) approach to identify turning points in the market after a correction is to wait for the VIX to first spike and then reverse lower.
Below are two charts that show (albeit it not a sophisticated approach) that the VIX DOES seem to do a decent job.
S&P 500 Daily
Some Caveats Before Going Further
- The character of the stock market has changed over the last few years – there should be little argument that both the volatility and the speed with which moves now occur have increased.
- Too many investors believe that all stock market indicators produce strong buy and sell signals. This is simply not true. Some indicators provide excellent buy signals but lousy sell signals, and vice versa so please don’t think any single indicator can provide you with accurate signals to move in and out of the markets. In this case, we are looking at only the buy side of the indicator – for good reason.
- Investors should never use any indicator in a vacuum. No, the game is a wee bit harder than that. The trick is to find a quiver full of weapons to use, and then know which arrow to use and when.
With the necessary disclosures and disclaimers out of the way, let’s get to our buy signal.
Our VIX Buy Signal
- The idea is to use the VIX and its 20-day moving average. Simple enough, right?
- Next, we need to calculate the number of standard deviations the VIX is from its 20 DMA. A little tougher, but a quick Google search should do the trick.
- When the VIX first moves more than two standard deviations from the 20-day, and then reverses below the two standard deviations line, a buy signal is flashed.
- That tells us the market has experienced a correction and a corresponding spike in the VIX.
- Then, when the VIX moves back below the two standard deviation line, it tells us that volatility is retreating.
- This in turn means the correction in stock prices may have run its course.
Since 2011, there have been 21 “initial” buy signals given. Note this indicator often produces “double-barreled” buys — as the VIX oftentimes spikes, retreats and then spikes again. For our purposes, we are using only the first buy signal.
- Of those 21 buy signals, 17 have led to higher prices in the ensuing weeks on the S&P 500 which means when our VIX Buy Signal occurs, the odds of success are 81%! Not bad, eh?
- 5 days after an initial buy signal (looking at the stats back to 1995) the average gain on the S&P is +0.27%, which is exactly 50% better than the average gain of +0.18% for all 5-day periods.
- 2 weeks after the buy signal, the gains in the market are again about 50% better than average (+0.53% vs. +0.35%).
- 4 weeks later, the S&P’s average gain has been +1.11%, which is 61% better than the average gain of 0.69% for all 20-day periods.
When eye-balling the chart of this indicator, it is clear that this indicator has been quite good over the past two years. In short, the buy signals have consistently provided investors with very good opportunities to BTFD’s.
The Latest Signal
The latest buy signal was flashed on March 17 (the one before that occurred at the end of January) suggesting (there are never any guarantees at all in this business) this indicator does seem to tell you the odds favor the bulls for the next few weeks. To be sure, the recent dip wasn’t much — and of course there is a chance that it isn’t over – but our VIX signal did flash an initial buy and, with 81% odds, you couldn’t be blamed for buying this little dip.
[Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.]
*http://www.benzinga.com/trading-ideas/long-ideas/14/03/4408941/a-vix-buy-signal-worth-watching? (Benzinga.com © 2013)
VIX is the ticker symbol for the volatility index that the Chicago Board Options Exchange created to calculate the implied volatility of options on the S&P 500 index for the next 30 calendar days. The formal name of the VIX is the CBOE Volatility Index [and informally as the investor fear guage]. Below is some introductory material on the VIX offered up in a question and answer format: Words: 915 Read More »