Maybe I’m making too much of this, but last week I created a chart overlay combining the VXX (candles below) and the current price of the SPX (purple line). Some obvious trends became immediately apparent. I actually keep this chart running live throughout the day to get a pulse of the overall sentiment and as a tool to help evaluate risk/reward.
Observations:
- Volatility goes up, price goes down. Easy enough.
- Volatility is in a falling wedge pattern.The falling wedge is generally viewed upon as bullish pattern that begins wide at the top and contracts as prices move lower. The bullish reversal pattern is confirmed when the price moves out of the wedge. Notice today that volatility finished right on the trendline marking the top of the wedge. This implies that volatility is going to rocket through or reverse down with odds on a breakout. If this happens, the market should sell-off just as heavily. Excluding other observations, this alone keeps me lightly positioned in swing long securities.
- The large gap on the chart between price and volatility is generally short lived and has proven to snap back aggressively. Notice how large the gap is between price and volatility today. If the snap back comes soon, it could be violent and swift.
I’m not posting this to scare everyone and say that there is no doubt that the market is about to move down significantly. However, patterns do repeat themselves and seeing this data can help you determine your risk in this market. Knowing nothing else, this chart says that the market is over bought. I’ll remain in the day trading camp and less involved in swings until this works itself out.
Have a great Friday.
