Vix Hits $28 - Fear Level Rising
A: I don't want to cut and paste all of the doomy credit news as of this past week, as I'm sure most readers of this blog are aware of them; Freddie & Fannie to be nationalized, Lehman worries, Foreclosures, WaMu's ALT-A problems, Wachovia's problems, and on and on and on. After twelve months or so of discussing this credit crisis in depth, I have to say, I'm getting tired of it. Not because I want it to go away, I do, but because its emotionally draining discussing the problems that our financial system is facing right now. Looking away doesn't help, and keeping your head in the sand is a side effect of the powerful force of denial. With stocks getting wrecked, main street is seeing first hand how bad it hurts. Which brings us to what could ultimately prove to be one positive thing, the rising VIX!
It's not that rising fear is a good thing, it's that rising fear usually means the selloff is nearing its end. I mentioned the VIX a number of times on this site as an indicator of fear, and a signal to traders as to when MAY be a good time to cover your shorts and open new long positions. The theory goes, buy when the VIX rises and fear is high and sell when the VIX is low and complacency sets in. It works because generally speaking, fear is high when markets are in turmoil and getting hit; at the same time the vix is low when complacency sets in and euphoria/stocks is high. So, you are buying low when stocks are out of favor and selling high when stocks are flying. When a capitulation occurs, that is a fierce selloff where many investors 'throw in the towel', that is usually when the best money making trades are available. The problem is finding the exact bottom which nobody knows.
When I see the VIX above 28 or so, that is when I like to start methodically covering my shorts and begin opening some new long positions for an eventual bounce. It takes discipline to trade this way, and I must admit, I lacked some discipline in the past few weeks and didn't follow my own advice this time around; I covered my shorts when the VIX hit 25, about 15 days too early and got caught with my longs in this extended downrun. Oh well, live and learn. If I did what I usually do, I would be covering shorts now, and start to get long around here.
Here is the VIX as it just passed through 28, indicating a rising level of fear:
As I see it over the past 2 months, here is the performance of the major indices:
DOW ---> Down about 2,000 points or 15%
S&P ---> Down about 190 points or 13%
NASDAQ ---> Down about 280 points or 11%
Ugly. However, recall all the analysts that told us to buy at much higher levels because all the talk of the credit crisis is clearly not hurting stocks and therefore the recession is expected to be short & shallow. Well, that didn't work out too well. I'm not here to tell you to go out and buy stocks, I will never give you advice like that here. But I do want to point out that the markets are a discounting mechanism and are in the process of pricing in the hit to corporate earnings that is to come, in addition to the uncertainty caused by the ongoing credit crisis, problems with the GSE's and financials, high oil prices, asset/credit/housing deflation at the same time as commodity inflation, and so on. It really is a perfect storm.
The only positive I can say comes from the trader in me. With the VIX above 28 and rising, and fear levels high, we may be close to a short term bottom in stocks assuming an event does not occur. By the way, I would certainly consider the nationalization of Freddie & Fannie an event. Let's see if the trading theory tied to the VIX works out over the next month or so, or if the fear level leads to another crisis of confidence causing another shock to our system.
Comments (16)
Umm, just got a margin call. I can see it already, I sell, market bounces.
Posted by margin call | July 11, 2008 12:11 PM
Tell me when you sell then! I'll buy more.
Posted by Noah | July 11, 2008 12:21 PM
My sense is that the market is going to remain skittish throughout the summer with the potential for a big sell-off one day in the summer when experienced souls are off at the beach and the kids without real experience of these kind of markets are on the desks.
My other fear here is that we've yet to see Q2 earnings. My sense is that the market is pricing in bad but they could be worse. Who knows what C, JPM, BAC, LEH will post.
Posted by Anonymous Banker | July 11, 2008 12:22 PM
Anon Banker -yea, me too. We are entering a new trading range. Who knows how low it takes us before any bounce. But as you say, we are yet to see how bad those earnings are. I have a feeling though that the stocks will bounce on the earnings. Just a feeling. But in no way is this problem over. Asset/Credit/Housing Deflation is a BITCH!
Oh, and that debt problem too.
Posted by Noah | July 11, 2008 12:27 PM
All technical and sentiment indicators point to at least a "dead cat" bounce. But I worry that the issues we are seeing in the economy are unprecedented and the old rule book is meaningless. I am staying away.
Posted by EV | July 11, 2008 1:42 PM
"The problem is finding the exact bottom which nobody knows."
I kinda see alot of the market players are like the kids in the back of the station wagon asking Dad - "are we there yet!", "are we there yet!"
And Dad says - "Yeah we're here." Only to get slammed.
We are fast approaching 10k and not heading towards 15K.
So, yeah keep having faith in your bottom while looking for your bounce.
Didn't the Chinese say to Bush, early in his Presidency, "May you live in interesting times."
Posted by Jose | July 11, 2008 2:09 PM
Well Jose, if you read this site I think you will agree that I am fully aware of what is happening out there and how this story will end! Additionally, this is really the first time EVER that I am discussing a trading bounce, and that is only because of how I interpret the VIX, from my trading experience.
Discussing a trading bounce, is just a discussion on what I personally am thinking on this particular day.
Posted by Noah | July 11, 2008 2:11 PM
PS: I said, "...short term bottom"! Cant be more clear than that! I do not expect a permanent bottom on this run.
ARE WE THERE YET?
Posted by Noah | July 11, 2008 2:18 PM
Noah,
I think in many situations this would indeed be a time to buy, anticipating a bounce. And it may very well turn out to be. However, this it one time when I think the bad economic news will only continue to slam repeatedly, so I think the bounces will become increasingly less bouncy and very short in duration. That scenario takes some real guts for investors. I haven't read any numbers recently on trading volume, is it still very low?
Posted by brenda | July 11, 2008 4:56 PM
Yes with the credit crisis ongoing for a year now, its like a repeating cycle again and again. However its so on edge take a look at Indy Mac shut down after a run......That bank also seemed like they would give loans out nto anyonme though here in Tucson Arizona I am handling several short sales for clients that refinanced their loans with Indy Mac into that "Super" pick your payment and I have no clue how anyone would of given either of these clients a cash out refinance its amazing. I guess this is all just part of the tough times for the financial and real estate sectors.
Posted by Michael Oliver | July 11, 2008 11:44 PM
When it comes to trading I trust my instincts (and yours too btw, which are excellent), on what the big direction is - but I never bet against it! The unfortunate reality is that in most major market sell-offs leading to a recession, the end is far away and all the bounces are mere wobbles when viewed historically (as opposed to in the heat of the moment).
Posted by Ed | July 12, 2008 8:39 AM
the key to the markets right now are the financials. When they have bottomed you can get long again for a snap back rally. When the shorts cant pound the financials down anymore get ready for a surge. I thought that was going to happen last week but all the fear from rumors ruled the week. IMO the easy money has been made on the short side for now. When will the Manhattan real estate market catch up with the reality on the ground? Anybody else notice the taxis are empty?
Posted by Mark | July 12, 2008 12:04 PM
I think this was the worst week ever for the economy in a long time. The near collapse of Fannie and Freddie and the collapse of IndyMac make the downfall of Bear Sterns last March look like the "good old days."
Posted by Donald | July 12, 2008 5:02 PM
Where do you find the VIX index?
Posted by lawrence | July 12, 2008 5:46 PM
lawrence,
here is a link to Yahoo Charts for Vix
http://finance.yahoo.com/q?s=%5Evix
Noah,
I must admit, this was timed perfectly after seeing how the market reacted after earnings reports. Your #4 comment was spot on.
I bought some too so if you want to speak up about when you may sell, feel free!
Posted by paul.b | July 18, 2008 10:15 AM
thx Paul! Im holding for now, but have some stop limits in to protect some gains if we happen to rapidly sell off. But I think this rally will have legs and we havent even discussed really squeezing the shorts, that could exaggerate the rally if it continues.
Lets remember, we are down about 2300 DOW points in 6 weeks, and have only come back 600 points now. We could easily fly up another 400-500 with little resistance over the next few weeks. Lets see how financials hold out and if news is not so bad, or if oil continues to plunge that could power the rally.
Posted by UrbanDigs | July 18, 2008 11:35 AM