Tuesday, May 23, 2006
Yesterday we discussed the VIX, market volatility index. If you recall, a decreasing VIX means that market volatility is contracting. Over the past two years market volatility has been decreasing and over the past year volatility levels moved down to early 1994 levels. Consider that the VIX is also a good measure of investor fear. Fear levels have been very low to the point of complacency over the past 12 months. Smart investors take advantage of the inefficiencies created by emotions. Since emotional levels have been at multi decade lows it has been harder and harder to find inefficiencies to exploit. Alas, this week we experienced an overwhelming breakthrough on the VIX. Note the monthly chart view of the Volatility index below: This is good news indeed. The spike represents an injection of fear in the market that has wiped out complacency in a matter of days. We are already seeing new and promising set ups emerge as a result. Today's market: The market is now basing nicely and yesterday traders were even whispering the words "Black Monday." More frightening words were never spoken and this is just the kind of overly bearish positioning that the market needs to put in an immediate bottom. Like a beach ball being held under the water, we should see prices shoot sharply higher in a relief rally that will surely surprise many. We believe that this rally will be tradable, but be ready to quickly switch allegiances once the downside pressure is relieved. This market has not yet created the even better buying opportunity we believe will emerge.