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Today's the Key Day for VIX


If it closes higher, the signal will be confirmed.


Here's some fodder for you VIX chart-a-holics via the Wall Street Journal (Hat tip Ryan at Ticonderoga).

Click to enlarge

Now, everybody's been making hay out of the VIX, the so-called "fear gauge" that measure options volatility. It's been down so far every day this year, to levels not seen since April 2008 (when it was, incidentally, on its way up, not down). But it's also brought the VIX to near a rare technical sell signal, according to Robert McHugh of Main Line Investors (which comes to us via UBS' Art Cashin).

The VIX, he notes, fell through "its bottom-boundary two-standard-deviations Bollinger Band Monday." (For more on Bollinger Bands, go here.) He notes other sell signals were triggered in September 2007, February 2008 and May 2008, and each one led to a big selloff. Yesterday, the VIX closed at 17.55, with the Bollinger Band at 17.70. What you'd have to see next is a move back above that lower band, and with the VIX up 4% this morning at 18.29, that's happened,

"Are sell signals in the VIX reliable and significant? Oh, yes they are. Sell signals from the daily VIX are rare."

For more on this, the Evil Speculator lays out the ground rules of this sell signal, and adds "the sell signals are far more accurate than the buy signals" and if the signal is actually coming, it'll come in the next two days.

"So-called Fear Index"? That's actually the proper use of "so-called."

And it's the proper use of charting in regards to the VIX, in my opinion. All "rules" come with caveats, but by and large, VIX rules that bank on near-term mean reversion are worth a look. I tend to think countertrend plays work better. Like, for example, if the VIX now lifts to overbought in the next few days, that's potentially a good buy signal as it's countertrend to the general market direction.

But here's The Rule, from The Evil Speculator.

For a $VIX confirmed signal you need three events:

1. A close outside of the 2.0 Bollinger Band (20-day SMA)
2. A close back inside the 2.0 BB - this issues the signal
3. A higher close (sell) or lower close (buy) than the close of the day back inside the 2.0 BB -- this confirms the signal.

Once you get those three events a major reversal usually occurs within the next week. The sell signals are far more accurate than the buy signals.

So today's the key day. Steps 1 and 2 have happened, so if the VIX closes higher, we'll achieve Step 3. Now there's no specific parameters here, other than "major market reversal," so keep realistic here. Just food for thought.

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