VIX/VXV and New Lows on NYSE – Fear in markets
Based on years of financial market analyses, I have developed several models that help me predict trends in the value of the US S&P 500 index. When US markets are in an upward trend, other markets can also climb; when US markets are experiencing difficulties, this often results in difficulties in other global markets as well. My models can also be applied to other sectors and regions.
- There are two types of indicators:
- delayed indicators - they appear at the beginning of new trend; trend direction is already shaping up, but is still not evident to majority of investors
- early indicators - they appear before new trend starts to shape up and may take some time to become evident. These are based on various breadth indicators.
Increased volatility or VIX is an indicator of increased investor fear. They are willing to pay more just to protect their investments, causing VIX to rise. The higher the value, the more expensive the insurance.
- Sell signals
- - ratio between one-month VIX volatility and three-month VXV volatility and the number of stocks reaching their new lows on NYSE - chart symbol PL
- - rate of change of ratio between one-month VIX volatility and three-month VXV volatility (the so-called fear index) – chart symbol VX
Let’s have a look at how the model works. The charts below illustrate how the model warned us to exit the market. PL indicator had been sending signals of the approaching financial crisis in 2007, of the 15% correction in 2018 and the Covid bear market in February 2020.
Indicator From 2009 to 2021, the VX indicator sent signals on various occasions, warning us of a number of SPX index corrections. Some of these warnings did not turn into major corrections. In these examples, you could simply re-enter the market based on the main model or on buy signals of the midterm model.
Advance/decline and volume based indicator – Money whither art thee going?
The indicator I prefer the most and that which sends signals when money is flowing out of stock markets or pouring into them is based on the ratio between the number of advancing and declining stocks. This indicator may appear as a delayed or early indicator.In any case, it is a highly reliable indicator and whenever it appears, it is usually not a good sign for those investing in stocks.
- Buy and sell signals
- ratio between advancing and declining stocks on NYSE – delayed indicators
- ratio between the volume of stocks on NYSE and NASDAQ100 that investors bought or sold - delayed indicators
- indicators are marked with crosses and triangles. The bigger the symbol, the more significance it carries when I’m making a decision on whether to sell or buy.
The chart below illustrating the period between 2007 and 2021 speaks for itself. Just take a look at the number of red crosses during the great financial crisis or during the Covid crisis. These are periods when you do not wish to be in stock markets.
OK, the model seems to be working when it comes to exit out of the market. What about re-entry?
Decision to re-enter the market is also made in accordance with the indicator based on the ratio between the advancing and declining stocks. When high enough levels are reached, it means that investors are optimistic and that it is time to enter the market. These indicators are known as the Breadth Thrust indicators. The points indicating the right time to enter the market are marked on the chart with a blue and black cross.
The chart below contains another Breadth Thrust indicator that has proven highly reliable. It appears after the correction bottom has been reached.
What does it look like when all indicators are merged in one chart? Chaotic? Not really if we follow the rules.
I see. Interesting. I have already seen many strategies, but they only appeared nice in theory; however, they do not work in practice because the “buy n’ hold” strategy turns out to be a better solution. Is the strategy applying the ADV/DEC indicator even profitable?
This strategy is highly profitable and goes well beyond the “buy n’ hold” strategy. The investor exits the stocks/funds at the beginning of the correction or bearish trend, and return immediately after the first signs of recovery.