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What the VIX can tell us About the Market

March 04, 2018

Any time the VIX drops under 10 it’s a trap. Yet, many traders fail to understand that.

We’re no strangers to that argument. We’ve used it countless times.

When the VIX dropped below 10 in June 2017, it exploded from 9.75 to 13 days after, resulting in a pullback in major indices, too. In July 2017, the VIX fell to a low of 8.84, a sign of eerie calm before the storm. Just weeks later, the VIX spiked to 17.3 as the Dow Jones Industrials slipped from 22,179 to 21,600.

The problem with the VIX under 10 is that it’s a sign of calm. Every one thinks all is okay. Folks continue to buy just about everything on the idea that nothing troubling is on the horizon. And unfortunately, many fail to seek protection as a result.

But when the VIX drops under 10, it’s a sign to protect your portfolio.

In early August 2017, the markets hit new highs of 22,179. The VIX was still under 10. No one expected anything was wrong. Analysts were still telling traders and investors that they still had plenty of time to buy the rally. It was far from over, many noted.

Not long after –as tensions boiled with North Korea- the VIX exploded to 15.36. The Dow Jones slipped about 200 points in just days. Any one that wasn’t prepared for even the potential for failure lost money.

We can see that this same thing happened several times between May 2017 and February 2018. In early January 2018, the VIX fell to a low of 8.92. And again, an eerie calm hit the Street. Investors continued to buy, thinking nothing of it. Weeks later, the VIX exploded to a high of 22.88, as the Dow sank 1,000 points.

History proves this to be true.

However, the VIX can also tell us when things have gotten a bit too rocky. As the VIX spiked to 22.88, notice what other momentum indicators began to tell us, historically. Relative strength was above its 70-line. MACD pushed too high, too fast. Williams’ %R was above its 20-line. Each time this same setup occurred since mid-2017, the VIX pulled back and markets began to recover.

It’s why it’s essential that we always pay close attention to what the VIX is telling us.

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