Warning!! Volatility Storm on the Horizon

By | March 21, 2017

The Volatility Index has been in hibernation for the past four months, languishing below the 13 level, as the S&P 500 index has been tracking higher and in rally mode. Conventional thinking would be that as the broader market moves higher and questions of valuations and sustainability continue to be debated, traders and institutions would be hedging positions. That does not seem to be the case as measured by the Volatility Index; there is simply very little fear evident in in the “fear” index.

The daily chart of the VIX shows it moving in a horizontal consolidation channel between resistance at the 13 level and support in the 11 area. Bollinger bandwidth and the average true range readings are low, reflecting the overall range contraction. Periods of low volatility, like this current one the Volatility Index is undergoing, are often followed by periods of high volatility, and usually the longer the consolidation period the larger the volatile resolution that follows.

In addition to the price action on the daily chart there a series of cycle highs can be seen on the weekly timeframe. The vertical cycle lines and the cycle arcs, mark a 21-week period of volatility highs, which are well correlated to the lows on the S&P 500 index. Another $VIX high and an inverse S&P 500 low is scheduled for the beginning of April. The absolute highs are preceded by preliminary periods of perturbation or increasing degrees of volatility that are not necessarily reflected in the price action of the S&P, but arrive suddenly as large pullbacks in the index. Currently, the VIX is sitting at the lower end of the consolidation channel and under normal conditions would be in position to bounce higher, but now this level in price is being reinforced by the bullish cycle in time, and the combination has the potential to power a strong and sudden move in volatility and a corresponding downdraft in the stock index.

The S&P 500 has been moving laterally this month above support at the 2360 level. Moving average convergence/divergence has made a bearish crossover and is tracking lower and Chaikin money flow is falling off on heavy overall volume. The index looks like it is preparing for a pullback. Entering a short position in the S&P 500 or going long volatility at current levels seems like a low risk/high reward trade, but the more conservative approach would be to wait for a break above the 13 level on the VIX chart or a break below 2360 on the S&P 500, as triggers. In either case, trading based on a volatility index is by its nature immoderate, so planning on taking a quick profit or loss is a smart strategy.

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