“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.