The VIX (fear gauge) and SPX (S&P 500) correlation is a simple one. If the market is down and the VIX is also down this is a good bullish sign. If the market is up and the VIX is up, like we saw yesterday, this is a good bearish sign.
The VIX should be watched by all traders. You do not have to watch it during the day but at least take a glance of it at night when you are doing your charting. If you would have done that over the last couple of days you would have known we are bearish in this market.
Let’s take a look at the charts.
A look at the market shows a lot of choppiness and a tight range for the last 5 days. One thing to point out is the large down day we had 3 days ago. Let's see how the VIX reacted to that large down day.
Three days ago the VIX had a huge move higher. It exploded off the 50 day moving average and engulfed the previous candles. Looking at the next day in the SPX we see that we actually regained all those losses in the market. But what about the VIX? We barely moved! Now one should expect a move that is equal and in opposite directions on the VIX, but the VIX barely moved that day. This is a red flag and is bearish. People were not buying the rally and still buying out of the money puts which pushed up volatility.
Moving on to the next day we saw the market go green while the VIX was up 4%! This is another red flag the people are not buying this rally, and was a good indicator not to get heavy long yesterday. The SPX ended up finishing down .7% for the day. Again the market is trading in a tight range for the last 5 days but the VIX is breaking out higher. This is definitely a bearish sign.
The VIX and SPX correlation should be watched to help give you clue what the market is thinking. It is not always this simple and easy but this time there were clear signs.
Get Ryan's Top Six Trade Setups for Profitable Trading eBook for Free!