Justin Sullivan
Wall Street’s fear index is based on expectations of market volatility. Professionals use and trade this volatility in a variety of ways. But the average investor doesn’t. Nonetheless, he or she can benefit from the message sent by volatility.
Let’s explore with a chart.
Chart
Please click here for an annotated chart of volatility ETF The ETF has a tracking error compared with the CBOE Volatility Index
I’m going to leave out the intricacies of volatility in our discussion. After all, the purpose of this article is to help the average investor get good returns. The VXX is an easy-to-follow ETF, and that is the reason for using it here.
Please note the following from the chart:
• The VXX goes up when the market goes down, and vice versa.
• Moves in the VXX are exaggerated compared with those of the stock market. An investor may want to compare moves in the VXX with popular ETFs such as S&P 500 Nasdaq 100 ETF small-cap ETF and Dow Jones Industrial Average ETF There are separate volatility products for those indexes, but here we are keeping things simple.
• The chart shows that during the “go-go” days when the market went straight up, volatility was low.
• There was a big initial spike in volatility that was accompanied by heavy volume.
• As shown on the chart, subsequent rises in volatility didn’t reach the previous high levels.
• Subsequent volatility spikes have been accompanied by lower volume.
• The volatility is oversold, according to the relative strength index (RSI) shown on the chart.
• The chart shows that volatility is now near the bottom of the recent range.
• The pattern is a topping pattern.
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The message
The message from the foregoing is that extreme volatility — when the Dow has been up or down by several hundred points — may be close to subsiding. For practical purposes, dips in the market may become short-term buying opportunities unless something fundamental changes.
Caution
VXX shows a significant tracking error compared with its underlying index. For this reason, consider avoiding the use of long-term charts of the VXX. Use short-term charts only.
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.