Would you hire a plumber to fix a broken bone? No way!
Then why are so many traders applying the WRONG strategy when it comes to the SPY — the world’s most heavily traded ETF?
It’s like playing with a live power wire.
One wrong step and next thing you know you have electrocuted your trading account.
Did you know it is more and more common to see periods of extremely low volatility mixed together with a “melt up” attitude in the markets?
This can leave you feeling left out, missing trades, or even worse, being caught on the wrong side?
What if I told you there are ways to help you predict almost 100% of market reversals and it doesn’t even involve the “widow-maker,” the VXX?
Halloween may be over, but this trick and treat could potentially help you predict the next market sell-off!
It’s finally time you learn the correct way to trade the SPY.
The VIX is a symbol for the Chicago Board Options Exchange’s volatility index.
It is the measure of the implied volatility of a wide range of options that are in the S&P 500.
You may have heard this more commonly referred to as the “investor fear gauge,” because it reflects directly the investors’ willingness to place bets on the market.
How do you make heads and tails of this number?
Let’s take a look…
The VIX is the market’s best prediction of near-term market volatility.
Implied volatility is the options markets expected volatility of the underlying asset, in this case, the S&P 500 Index.
This indication of implied volatility by the options markets indicates to investors market stability or turbulence.
As you can see in the chart above, the VIX has periods of brief spikes along with extended valleys of “low” values.
Generally speaking, investors typically gauge the VIX as being “high” or “low” as a relative value instead of exact figures.
The “lower” the VIX, the more confidence investors have in the future price of the stock market.
This is usually found in a strong bull market like we are currently experiencing.
The “higher” the VIX, the less confidence investors have in the future price of the stock market.
This is usually found in times when investors are having financial difficulties with their portfolios, common during periods of weak market conditions.
How exactly does an unrelated market predict a stocks price?
Well, the VIX can be used to predict future values of the SPY since it is based upon the underlying assets volatility measurements.
As noted above, the “lower” the VIX, the more likely it is to see a steadily trending market.
But what if I told you that the VIX can also predict market reversals?
The VIX: SPX
Let’s take a look at this chart of the VIX and SPY overlapped and it shows quite an interesting picture.
At a glance you can notice some key price levels in the VIX that correspond with market pullbacks in the SPY.
Tip: Don’t worry this is easy to create on any brokerage application. Contact your broker and ask for overlapping charts to have this to reference.
It appears that $12 is a key level in the VIX, acting as a massive resistance line for that instrument.
Looking at April, the VIX made an astonishing low never seen this year.
Investors were very complacent with the market conditions at that time with markets steadily climbing higher.
No sooner than a week after this level was hit did the markets experience a bit of turbulence.
A similar pattern occurred in July and Sept, causing the Index to drop more than 5% and 3% respectively.
What does this mean?
As we learned, it means that the VIX along with the options markets are pricing in a period of “melt up” and euphoric trading.
Consumers and traders are continuing to feel comfortable with their investments and trading with complacency.
You and I know that traders have a short memory.
They tend to forget what they wore to work a week ago, let alone what the market did months ago.
Unfortunately, the tale of the VIX is scary and relentless.
It’s so terrifying, it’s close cousin the UVXY has been removed from trading and called “the widow maker”.
With this new tool I’ll be scouring the markets and stalking the VIX.
I will be making sure to load up with Put options to take advantage of this next period of market turmoil.
Keep your eyes peeled, the VIX may jump out at you and you don’t want to be caught with your pants down holding long SPYs.