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Trading Alert: It's Time to Buy Some InsuranceBy Jeff ClarkTuesday, September 7, 2010 Here's something for the bulls to worry about...  This is a chart of the Volatility Index (VIX). The VIX is often used as a measure of fear or complacency in the stock market. As the VIX rises, it indicates increasing fear and nervousness among investors. A falling VIX indicates investors are growing more comfortable with the stock market.
The blue lines on the chart are Bollinger Bands. Bollinger Bands compare volatility and relative price levels over time. They attempt to illustrate the maximum probable range of prices for a stock or an index. If you plot a chart of any stock against its Bollinger Bands, you'll find the stock stays within the bands the vast majority of the time. It is rare for a stock to close outside the bands. When that does happen, it indicates an extreme condition.
As you can see from the above chart, the VIX closed Friday below its lower Bollinger Band. In other words, the VIX – the market's best measure of investor fear – is extremely oversold. Investors are too complacent.
Really?
Talk about a head-scratcher. Just last week, everybody was worried about the potential for a stock market crash. The American Association of Individual Investors reported its highest percentage of bearish respondents since March 2009. And now the VIX is oversold?
Could it be that while everyone seems to expect the market to crash, nobody is afraid of it happening? Or has the 5% rally over the past three trading days been enough for investors to gain confidence in the market once again?
Who knows?
All I know is that whenever the VIX closes below its lower Bollinger Band, the stock market makes an important intermediate-term top within days.
Take another look at that chart of the VIX. Then, take a look at this chart of the S&P 500...
 The circles on the S&P chart correspond to the circles on the VIX chart. They indicate the days when the VIX closed below its lower Bollinger Band. Notice how the stock market peaked shortly afterward... and was followed by a rather dramatic decline.
Will the same thing happen this time? Who knows? Nothing is guaranteed. But since the rally over the past few days has eliminated the market's oversold condition, spanked the overly aggressive bears out of position, and is now bumping into resistance, it's probably a good idea to buy some insurance.
After all, with the Volatility Index oversold, put options are cheap.
Best regards and good trading,
Jeff Clark
Further Reading:
The Best Time to Short Stocks |
Big Treasury fund (TLT) down two weeks in a row for the first time this year.
REITs on fire... 52-week high list includes no less than 20 REITs.
Big Tobacco stocks Philip Morris, British Tobacco, and Lorillard all surge to fresh 52-week highs.
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