Use Fear to Your Advantage with the S&P 500 Volatility Index (VIX)
Feb 2nd, 2009 | By Charles Delvalle | Category: Chart of the DayIt’s a widely known that dogs have the capability to sense fear. In that regard, I consider myself a Pit Bull. I can sense fear in the market from thousands of miles away.
Then I “lock my jaws” as I exploit that fear and make lots of money.
No, I didn’t alter my genes to gain an unnaturally strong sense of smell. And no, I can’t really lock my jaws like a Pit Bull. I just look at the S&P 500 Volatility Index (VIX) and everything becomes clear.
What Is the VIX?
The VIX is a basic measure for volatility in the market. Higher levels of volatility in the market coincide with higher levels of fear. Higher levels of fear usually mean investors will pull money out of the markets and you see an overall drop in market value. So when you see the VIX rising, the market usually drops.
How Do You Use the VIX?
The best way to use it is as a tool to supplement your existing technical analysis.
Let’s say the market takes a huge drop one day. How do you know that this is the beginning of a genuine leg down? Sometimes it can be hard to tell. But if you look for a major technical break in the VIX to occur around the same time, the odds of you being right about that drop increase substantially.
A Major Opportunity in the VIX
Take a look at this chart to see the opportunity I’ve been talking about…
This is a three-year chart of the VIX. As you can see, it’s been marked by very clear support and resistance lines – one just under 20 and the other just under 40.
As you can see, the one just under 40 was tested earlier this year. More important, in the past few weeks it tested it again… and managed to close significantly above it.
At the same time, the Slow Stochastic indicator at the bottom of the chart (which is smoothed out over 14 weeks) is showing the VIX as oversold. Nearly every time the Slow Stochastic indicator has become oversold – meaning the red and black lines drop under 20 – the VIX went on to rise for the next ten to twelve weeks.
If the VIX is rising, that means the Dow Jones should be falling, possibly breaking under 8,000 sometime in the next few weeks and head towards 7,000.
The play should be obvious. But I’m going to point it out anyways because I’m feeling saucy.
If the Dow Jones drops under 8,000 as the VIX spikes, buy a put on the Diamonds ETF (NYSE:DIA), which is an ETF that tracks the value of the Dow Jones Industrial Average.
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Charles Delvalle is a self-taught market-timing professional and value analyst who's followed and invested in the market for the past ten years. He uses a unique combination of technical and fundamental research to pinpoint rapid profit opportunities with stocks and options.
Charles is also a staunch contrarian and takes pride in finding undervalued sectors and discovering undervalued, cash-rich companies. He frequently mocks government stupidities and points out the "inaccuracies (or lies, take your pick) that government reporting frequently dispels as "truth".
