Here’s the Bottom Line at the top today…
The VIX – Wall Street’s “Fear Gauge” and what I consider the one number you should be watching this week – is now telling you that the dominant emotion in the market is switching from Greed to Fear. Fear-based markets move lower, which means now is the time to take profits or buy “protection” for your portfolio as a 5-15% correction appears imminent.
I’m purchasing protective puts on the Nasdaq 100 with a target of $415 and $400. Those that prefer to use an ETF to protect their portfolio may consider Proshares Short QQQ Shares (PSQ).
The VIX will signal an “all clear” for the market once it crests above 22. Hold off on buying new stock positions until then.
Now let’s dive into WHY…
Nick messaged the following to me yesterday afternoon…
“Market feels like it's hanging on a thread.”
I know, it’s short and simple, but the message goes right to the point. Keep in mind, he typed that when the market was hitting new highs!
In the name of keeping things simple, let’s talk about the CBOE Volatility Index. We call it the “Fear Index” for a reason. The more fear investors feel, the higher the index goes.
Like so many indicators, the VIX is a complex set of calculations that most investors won’t have any idea how to figure out. If you’re curious and nerdy like me, I included a look at the formula below.
Understanding the formula isn’t important. Understanding the implications of the readings themselves is, and it’s very simple right now.
The VIX has spent the last three months trending to lower readings. That’s good for a bull market because it indicates that investors have confidence in where stocks are going which translates into more money coming into the market.
That’s what has driven us to new all-time highs.
But recently, the VIX has started to trend in the other direction. Readings of the VIX have increased 50% over the last month of trading. That increase tells us that investors are getting more nervous about the next month or so in the market.
Connect the dots with me. Nervous investors start to do what? They sell!
Then things turn into a very negative cycle. Investors start to sell, the VIX goes higher, more selling, higher VIX, and on and on and on.
We’re not at that point yet, but we are at a critical level for the VIX. It will literally be the difference between the market holding near its highs or dropping 5, 10, or maybe even 15% during earnings season.
That point is the 18 level on the VIX. Look at the chart below. The last few sessions have seen the VIX run to that 18 mark. Yesterday we saw it touch this level, then the market rallied from its lows and things were “safe.”
Today, the VIX is trading above 18, and a close above that level is likely to accelerate investors selling as “fear” becomes the dominant emotion in the market.
That selling will continue while we see the VIX moving higher.
Keep an eye on the 22-25 level as the first point where the market begins to shift from fear back to greed as this will be the perfect point to start buying stocks at lower levels.
About the Author
Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.