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VIX Spikes Above Bollinger Bands


Waiting for the buy-on-the-dip mentality to return.


Yesterday's 12% jump in the VIX lifted the volatility index to 13.8% above its 10-day simple moving average. As noted on a number of occasions here, when the VIX is at least 10% above its 10-day SMA, this is usually a good time to initiate a short-term mean reversion play and go long the SPX and/or short the VIX.

While I have not discussed it as often in this space, another useful VIX mean-reversion signal can be derived from using Bollinger bands to determine when the VIX is overextended and likely to snap back. The simplest approach is to monitor when the VIX closes above the upper band of a 20-day, two standard deviation lookback period.

The chart below uses the standard 20-day, two standard deviation Bollinger bands to evaluate the moves in the VIX during the past year.

Click to enlarge

Note that following the largest sustained VIX spike ever -- during September and October of last year -- it's been relatively rare for the VIX to close above the upper band. There was one instance of a close well-above the upper band in January that marked a short-term bullish move, then there were two closes above the upper band at the end of February and the beginning of March that preceded the market bottom and strong bounce.

By historical standards, yesterday's close 4.7% above the upper band is a fairly substantial breach and suggests a short-term bullish bias. Given the narrowing Bollinger band width (bottom study), however, it obviously took a much smaller move to penetrate the upper band than it did in January, when the VIX was hovering around 50.

It seems as if lately, everyone has been looking for a pullback. The big question is how much of a pullback it will take to satisfy the bears and how soon it will be until the buy-on-the-dip mentality begins to dominate again.

For related posts on Bill Luby's blog, try:

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No positions in stocks mentioned.

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