Tuesday, November 29, 2016

SPX S&P 500 and SPX/VIX Volatility Ratio Weekly Charts

The SPX/VIX is a ratio of the broad market to volatility. When the ratio is high, the bulls are euphoric and every day is another glorious day higher for the stock market (a red circle market top). When the SPX/VIX ratio is low  the market mood is somber as stocks tumble lower and volatility spikes higher (a green circle market bottom).

Note the bottom that occurred on 11/7/16 the day before the presidential election as negative sentiment and doom and gloom was off the charts (low SPX and higher VIX). A brief math lesson. Think back to your days in school when studying fractions. A ratio is a fraction. The numerator is the top number in the ratio and the bottom number is the denominator. When the numerator moves higher, the ratio moves higher. When the numerator moves lower the ratio drops. When the denominator rises, it pushes the ratio lower. When the denominator moves lower, the ratio moves higher.

Therefore, when times are happy and stocks are rising, the SPX is moving higher and it sends the SPX/VIX ratio higher. At the same time, the VIX will be dropping since traders are fearless and complacent while chasing the upside. The lower VIX, in the denominator, also sends the ratio higher for a double-whammy bullish effect. The ratio is useful since it magnifies the moves going on in the market and helps identify the key inflection points. As stocks sell off, the SPX moves lower, the numerator, so the ratio moves lower, and volatility will spike higher, so the higher VIX also sends the ratio lower for the double-whammy bearish effect.

The SPX/VIX chart indicates that stock market bottoms occur at sub 95-ish while significant market tops occur at 170-ish and above. The SPX/VIX printed at 180 a day ago and now sits at 167. What do you think will happen?

Pulling off the SPX point losses from the red circles downward yields the following losses over a 1 to 2-month period; 120, 80, 50, 205, 210, 40, 60 and 50. So the average point loss off a red circle top is 102 SPX points. The smallest loss is 40 points and the greatest loss is the 210 point drop early this year. Throwing out the smallest and largest losses, the average drop is 94 points. Thus, a reasonable assumption would be for a pull back in the markets over the coming weeks of from 40 to 100 SPX points. This information is for educational and entertainment purposes only. Do not invest based on anything you read or view here. Consult your financial advisor before making any investment decision.

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