Stocks Are Bullish According To The VIX And Box Breakouts

Dr. Scott Brown

By Dr. Scott Brown

I can’t remember a time since 2009 at the bottom of a big crash when the public has been so anti-stock-market.  The Occupy Wall Street movement has certainly contributed to the angst between Joe Plumber and the NYSE. Mit Romney will most likely lose the presidential race because he has intentionally positioned himself as a self entitled poster boy of the 1%.  That message does resonate through the contemporary republican proletariat.  It seemed like a wise move at the beginning of the campaign. Romney’s campaign managers were out of touch.  They failed to understand the depth of recent economic suffering.  This suffering was induced by an evil band of collusion between mortgage bankers, credit agencies, Fannie and Freddie, and congress. Both republicans and democrats were responsible.  Bill Clinton started the ball of s&^% rolling downhill. Marisol and I have two friends who barely earn enough to keep up with astronomical house payments from primary residential purchases five years before.  Their banks refuse to refinance to lower payments.  These same banks received bail out money from taxes both of these families paid. These people are both republicans and pro-Romney.  But they hate Wall Street, CEOs, and most of all the stock market. Yet this is the very moment that the little guy on Main Street should be shoveling savings into stocks on Wall Street.  There are a couple of reasons for this.

VIX Decade

VIX Monthly Chart S&P 500 Comparison

VIX Annual

VIX Daily Chart

EMINIWeekly

E-Mini Weekly Monthly Chart 2012

EMINIMonthly

E-Mini Futures Monthly Chart 2012

VIX Decade thumbnail
VIX Annual thumbnail
EMINIWeekly thumbnail
EMINIMonthly thumbnail

Reason 1:  The VIX Divergence

First, the VIX has been diverging with regard to the S&P 500.  The index option market has become dominated by portfolio insurers over the last two decades.  These institutional money managers protect their hedge funds, mutual funds, and pension plans from downside risk through SPX puts or OEX puts. This in turn drives up the demand for these puts.  Increased demand drives up the implied volatility.  The VIX is simply an index of demand induced implied volatility fluctuations. The VIX is an incredibly useful tool when you understand it. The creator of the VIX is Professor Robert Whaley of Vanderbilt University. 

Read His Paper HERE.

In his own words…

“VIX is an index, like the Dow Jones Industrial Average (DJIA), computed on a real-time basis throughout each trading day. The only meaningful difference is that it measures volatility and not price. VIX was introduced in 1993 with two purposes in mind.” First, it was intended to provide a benchmark of expected short-term market volatility. To facilitate comparisons of the then-current VIX level with historical levels. Second, VIX was intended to provide an index upon which futures and options contracts on volatility could be written. In attempting to understand VIX, it is important to emphasize that it is forward-looking, measuring volatility that the investors expect to see. In the same manner, VIX is implied by the current prices of S&P 500 index options and represents expected future market volatility over the next 30 calendar days.

 

Reason 2: Box Breakouts

The second reason that the stock market is bullish is that the index continues to rise from prior box consolidations without falling back.  This is another way to say that the market continues to trend upward. Box is another way to say consolidation.  Nicholas Darvas coins the term in his excellent book, “How I Made $2,000,000 In The Stock Market!” Watching box breakouts on the daily charts keeps you responsive to adverse stock movements.  Box breakouts are very helpful when using mental stops.  This allows you to get out with as little as 3% mental stop. “Oh but a famous investing guru says to never use mental stops” you say? The reality is that stock option positions don’t work with hard stop losses.  If you are going to trade stock options you have to master mental stop loss levels.

Reason 3:  The Market is Bullish

Jesse Livermore was a notable stock trader at the beginning of the last century.  He made and lost a number of fortunes in the process.  He learned the importance of the long term trend. But it took him a number of years to do so.  Here is how you do it. Few stock investors understand the importance of gauging the trend on a very long term chart.  These are the weekly and monthly graphs of price movement where each bar represents a week or a month. If the market trend line is unbroken you remain strong to your conviction.  If the long term trend is bullish and unbroken you remain long. Otherwise you are best off to move to cash.  Shorting the stock market is more hassle than it is worth. This harkens to the deep wisdom of old Mr. Partridge as related by Jesse Livermore…

“I think it was a long step forward n my trading education when I realized at last that when old Mr. Partridge kept on telling other customers, “Well, you know this is a bull market!” He really meant to tell them that the big money was not in the individual fluctuations but in the main movements — that is, not in reading the tape but in sizing up the entire market and its trend. And right here let me say on thing: After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me.  It always was my sitting.  Got that?  My sitting tight!”

See Reminiscences of a Stock Operator (Wiley Investment Classics)

-Dr. Scott Brown

Ps.  Want more analysis like this?  Join my list here…

Enhanced by Zemanta