VIX and the Market Rallies Updated

by Paul Costa

Back on December 27th, I wrote this post looking at the interesting pattern in the VIX and the market.  In this post I  looked at the above chart and noticed the pattern in the VIX and the Market and I wrote:

Summary: What does this all mean, well for starters if this pattern continues the market has another bull leg in it for what could last 3 months or more. Based on the number of days the VIX has decline it is enough days to confirm a market bottom.   What will need to confirm it is a continuing decline of the VIX and a strong rally by the market- watch the 70 day moving average if it maintains a decline this pattern is confirmed.  

Updates: Changing the chart a little bit to reflect the October bottom, (the original post had the bottom in December) the market has now rallied for over 122 days from its bottom.  This time around the drop from the VIX peak to the bottom of the VIX is shorter since VIX has only peaked in the high 40's so the number of days for the rally can be shorter. 

Foreshadowing Tops:  Others have now begun to catch on this pattern, Zero Hedge just posted a similar article.   People are beginning to notice that the VIX and the market are nearing that topping portion on this pattern that we had mentioned. 

Marking Tops:  This pattern also is good at marking the markets tops. Whenever the VIX gets back down to 16 this typical was the end of the bull run.  With the VIX at 22 now it doesn't have to far to go.

Fakeout Tops: Typically once the VIX gets back to the low 17-16's the market will stop rallying and do another "fake" spike, where the market will drop and the VIX will spike, but the pattern will fall out.  The market then rallies a little more before the real VIX spike comes.  We saw this in January of 2011 and Febuary of 2011.  This also has occured half-way or a third of the way through the rally.  In 2010 it was a third of the through the 287 days and in 2011 it was about half way through the 323 days, so with the market having rallied for 122 days it is right about in the timeframe for this fake out. 

Forecasting:I believe this is what we will see next.  The market is very bullish and complacent with the current movement.  So if we do get a drop lower it could shake out some weak bulls and get the axious bears back into shorting.  Only to have them have to cover their shorts again as the market rallies.  Finally after that, the VIX will get back to the low 16's and tank, everyone will be bullish and that is that. 

Overall:  The market is pretty much overbought here, very bullish and has been trading on almost no volume.  This makes it ripe for a pullback but not ripe for some bearish selling.  Internals need to turn that way first.  This agrees with the VIX and Market pattern that has formed over the last 3 years. 

Read more http://www.pikertrader.com/main-page/2012/1/23/vix-and-the-market-rallies-updated.html