Volatility Archives | Opportunity Identified

January 10, 2015 | Posted by David Zarling, Head of Investment Research

A Little Fear About The FEAR Index

Back on November 13, 2014, we wrote about our concern over elevated volatility as part of our seven-part series on evidence currently warning of a possible trend change in the overall U.S. Equity market. Almost two months later, none of the issues identified have resolved and remain cause for concern that stocks are weakening and could lead to a large correction. The only piece of evidence, and the most important, that has held up is price. Since November 13, the S&P 500 has traded sideways in a volatile fashion with large percentage moves in either direction. The market is at a very important inflection point. Buyers need to step up in a big way to prevent another visit to the 1800s (-10%) on the S&P 500.

This brings us back to revisiting what is currently taking place with the FEAR Index, or VIX. As a reminder, the CBOE Volatility Index (VIX) is a forward looking instrument calculated from option activity, and reflects the market’s expectation of 30-day volatility. We like to look for divergences between the VIX and the US Market. We look for odd behavior. Normally, as would be expected, when fear/volatility increase, stocks decrease in price – and vice versa. However, sometimes a change in market sentiment from greed to fear (and the opposite also applies) can tip its hand. When we see fear/volatility increase along with market prices, we take notice. This is odd behavior and could be a warning sign that market participants (big money managers) are changing their mood. This was taking place back in November and continues to be an issue today. As George Soros once noted:

Volatility is greatest at turning points, diminishing as a new trend becomes established.

The chart below is an updated version of what we provided you back November. Note that volatility has continued to increase, both in the VIX and now in the price fluctuations of the market. This needs to resolve quickly. Those long this market need volatility to drop and new highs in the market to reestablish. Otherwise, the opposite will apply – new highs on the VIX and new lows in the market. A revisit to the 1800s would be likely. This market will require traders be nimble in the coming weeks+. Keep in mind that price is the final arbiter of value.

For your reference, I’ve provided a chart of this scenario from the 2007 top below the current day chart. This doesn’t have to play out again, but we should always sit up and take notice when volatility increases.

Trade safe. Don’t trade what you think. Trade what you see.

VIX Fear Index 2007 — 2007 Elevated Volatility

December 2, 2014 | Posted by David Zarling, Head of Investment Research

Want to Make Great Investment Decisions? Just Look Left. [Weight of Evidence, Part 6 of 7]

Using a weight-of-evidence approach is valuable for making quality decisions on desired or current investment positions. As technicians, we have a wide variety of tools at our disposal to anticipate potential rough spots, corrections, or buying opportunities. But that is all they are – tools of warning or anticipation. They give us an edge in identifying when and where to take on risk with limited downside. Finding asymmetric risk/reward opportunities is the epitome of what we do at 360 Investment Research. We don’t care about being right. We only care about being on the right side of the trade.

Over the past 5 posts, we’ve identified some warning signs for the overall U.S. equity markets. All of the posts carry weight as we analyze our long exposure to U.S. stocks. But none is more important than what we write about today – price. Price is the most important evidence. It carries the most weight. We can have all the common and proprietary indicators in the world and they mean nothing without the confirmation of price. Below is a diagram so you can visualize what we’re saying.

As you can see, we like to look for evidence to support our investment decisions. The best piece of evidence is price. What is it doing? What’s its direction? If price is making higher highs and higher lows, the trend is up. If price is making lower highs and lower lows, the trend is down. By analyzing price itself, we can determine the general trend and the potential change thereof. Using the diagram above, which shows the current status of the market, we can see that price moving to the right side of the scale would cause it to tip dramatically to the right into a new and potentially strong downtrend. In the same light, if the evidence on the right shifted to the left side of the scale, the swiftness of the uptrend would increase. So at this point in time, we are watching price like a hawk. How do we do this in reality? Simple. Just look left. When we analyze price using charts, we find the current price and look left. See the daily price chart of the S&P 500 below. Notice that price has been steadily making higher highs and higher lows. It is a beautiful staircase upwards, hallmarking an uptrending market. The exceptions are back in early February (SPX made a lower low and tested the trendline from the 2007 top) and back in mid-October (SPX made a lower low and tested previous highs/lows near 1825). Each time, the market recovered by subsequently making new higher highs without recording a lower high. When we consider this most important piece of evidence, the scale is easily tipped towards an uptrending market. All the other evidence only provides perspective in the event price changes and makes lower lows and lower highs. All the other evidence indicates caution is warranted. But, that doesn’t mean we need to short or be out of the market. Right now, price is telling us to remain long this market. As for the future, we’ll let price dictate what we should do next.

Look for our series finale on game planning and risk management soon.

November 13, 2014 | Posted by David Zarling, Head of Investment Research

The Curious Case of Elevated Volatility [Weight of Evidence, Part 2 of 7]

“Fear tends to manifest itself much quicker than greed, so volatile markets tend to be on the downside. In up markets, volatility tends to gradually decline.” ~ Philip Roth

The CBOE Volatility Index is often referred to as the FEAR Index. This forward looking index is calculated from option activity, and reflects the market’s expectation of 30-day volatility. We like to look for divergences between the VIX and the US Market. We look for odd behavior. Normally, as would be expected, when fear/volatility increase, stocks decrease in price – and vice versa. However, sometimes a change in market sentiment from greed to fear (and the opposite also applies) can tip its hand. When we see fear/volatility increase along with market prices, we take notice. This is odd behavior and could be a warning sign that market participants (big money managers) are changing their mood.

Below are two charts: one from 2007 and one from today (2014). Both show that while the US Market (in this case, the S&P 500) is making higher highs, the VIX is making higher lows. They are moving together. Odd behavior. In 2007, this was a clue that a change in trend was approaching. And as you can see, the same is taking place now. Does it mean that this is the top of the market for the foreseeable future? No. But, it means we’re going to keep close eye on the price action from here until this odd behavior resolves itself. Those who are looking for the bull market to continue want to see lower lows in the VIX and the market to hold onto these highs.

Stay curious, investor. Check back again tomorrow as we’ll have more to add. And if you find this information useful, make sure to share the wealth using the share buttons at the bottom of this article.

June 17, 2014 | Posted by David Zarling, Head of Investment Research

VIX Revisited

VIX Recently posted another 3 point indicator to sell equities in the very near term. It is possible the market weakness has already taken place. This is not indicative of a long term pullback, but can always be the beginning of one. Trade safe.