If there's one good thing about the volatility of the past week, it's that the CBOE Volatility Index (VIX) is finally showing signs of life. There is nothing wrong with a little fear, and with several banks going bust and a few others wobbling, that fear is more than justified.
A little fear can be a good thing, because it shakes out the so-called weak hands. The CBOE Volatility Index, also known as the fear index, could be headed for levels that have led to bullish reversals in the recent past.
On Monday, the VIX reached its highest closing point since late October. While the volatility index is elevated, it's still below levels reached last year, when the VIX topped out in the mid-30s on a half-dozen different occasions (shaded yellow).
Chart Source: TradeStation
Why is this important? Sharp inclines in the VIX (green) often coincide with buying opportunities on the S&P 500 (red).
This happened on numerous occasions last year (black vertical lines), but was dramatically evident at the Covid-19 bottom in April of 2020 (far left). At that time, the VIX skyrocketed to the mid-80s.
Chart Source: TradeStation
A few weeks ago, I wrote that the S&P 500 was at a major inflection point, and that the winner of the battle would gain the upper hand in the short term. The bears have broken the bullish uptrend and have assumed control for now.
Chart Source: TradeStation
The S&P 500 is now in the midst of an A-B-C-D pattern. The bounce from the large cap index's 200-day moving average (red) on March 2 represents point B of that pattern. The bears gained definitive control when that key moving average was breached on March 9t.
The bearish A-B-C-D pattern terminates near the 3800 level (point D). Just below is an area of significant support that was created in December (black dotted line), at 3785. This is now the level to watch.
Since the bears are in control, I'm not adding new longs here. In fact, I'm using rallies to lighten positions. Here are three reasons why, in order of importance:
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The VIX rising into the mid-20s doesn't have enough significance to indicate a bottom. I want to have cash in hand if and when a bottom is signaled.
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The increase in volume over the past few days in the S&P 500 (shaded yellow) isn't dramatic enough to indicate capitulation.
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The A-B-C-D pattern can only be completed if the S&P 500 falls to 3800 or below.
I realize that by lightening my positions, I may experience regret if the bulls regain control and stocks rally from here. Bottom line, I'd rather miss out on a rally than get caught leaning long if the 3785 level is breached.
