The VIX rallied, so there was a lot of fear in the end of May—a couple of fear spikes (you can kind of see what I’m pointing to here) that were eventually beginning to break down in the middle of June. So that presents an interesting opportunity here—in that we can use the VIX much the same way that we might do a market analysis.
For example, if oil prices themselves make a big move, but oil stocks don’t move, that may present an opportunity. Sometimes those asset classes will lag each other or lead each other and so forth. So in the same way that we might use a signal like that, we can use the VIX as well.
So let me give you a specific example, going back to this period of time here through May-June. There was a rally from June through August/September time frame that was very hard for traders to understand because there weren’t a lot of clean technical signals, and certainly no fundamental signals that were giving nice guidance as to how likely it was the rally would have momentum. And it turned out to have pretty good momentum.
So that little pattern I identified there through May-June—that was a head and shoulders. They don’t appear very often on the VIX, but once in a while they do pop up and they can be quite useful. There was one just prior to that in February-April/early May that would have indicated that fear should be on the rise, which did happen.
So let’s just draw a neckline across that particular head-and-shoulders pattern. You can see what happened here was that the head-and-shoulders pattern got re-tested twice. So we had it right there in June and again in late July, presenting entry opportunities to the upside.
Now, why is that? Again, the VIX is inverse to the market itself, so if traders have basically exhausted their bearishness here in the head and shoulders pattern from May-June, well it gives us an opportunity to identify entry opportunities. Every time we get back to that neckline, we can assume that we’re a little more confident about the value of resistance on the VIX, where normally we’re a little more cautious because the VIX can channel at low or high levels for so long, it can kind of stay flat like it did here in September and much of October. So that gives us an entry opportunity. And if you keep those time periods in your head there, we can think about—OK, so late June and mid- July gives us an opportunity. So let’s go ahead and look at how that appeared on the S&P 500. Late June—that was the first opportunity, and middle of July, right there. Both of which turned out to be lows in this upward-trending channel that we had on the S&P 500 that turned out to be a lot more durable than a lot of investors assumed. But we might have gotten a better heads-up on how strong that rally was likely to be.
John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.