The trade war is on! No it’s off. It’s ON! It’s off again… Anybody else getting bored by this narrative? It almost makes you just want to sell everything and come back in a few months doesn’t it?
Before yesterday’s late afternoon announcement of another round of (surprisingly large) tariffs the S&P 500 did seem like it was on a collision course for that 2872 all time high level.
Now there’s no question there are significant economic headwinds to give investors pause going forward which I’ll address in a future video but an objective observer would have to conclude that the momentum is still upward.
I get asked a lot if there are any indicators to determine whether a market drop is the real thing or just a false alarm. Before I get into one of my favorites I have to remind people that even if there were indicators that were right 80% of the time (a very ambitious success ratio) that would still mean that 20% of the time it’s wrong.
So it’s always best to cross reference a multitude of varying signals and see what the preponderance of evidence suggests. Then just trust it with confidence knowing that statistically, sometimes we’ll still be wrong.
There are complex indicators that would take some unpacking and a much longer article but let me give you one of my most simple go to crossovers that has a really good success ratio of determining whether a market drop is being taken seriously or not.
VIX9D : VIX ratio
The VIX index as we know is a 30-day forward implied volatility measurement, and for those who aren’t aware the VIX9D is very similar in construction except it’s a measure of 9-day forward implied volatility. So when the market gets “scared” it would make sense that it shows up quicker in the shorter term measurements and a little slower in the longer term measurements.
For those who study technical analysis this is a very similar concept to the difference between an exponential moving average and a simple moving average. Since exponential moving averages take into account recent action more heavily in the calculation, an EMA to SMA crossover is a pretty good metric to add to the tool box as is the VIX9D : VIX.
3 month chart of the VIX9D (white) and VIX (red)
* on Stockcharts the VIX9D still goes by the old ticker VXST
Notice how the natural state of things is to see the VIX9D (white) below the VIX (red). However when the markets get spooked a little and the VIX rises, the VIX9D rises faster.
So how can we tell whether market participants really are scared or whether it’s just a run of the mill down day in the markets?
This is just one of many indicators and should never be taken as a stand alone metric, but whenever the VIX9D crosses over the VIX index you can bet it’s a little more than just a one day scare.
And if we want to start building a larger picture we can include the VIX3M and VIX6M as well. The VIX3M is a 3 month measurement and the VIX6M is, yup you guessed it a 6 month measurement.
Normal markets: VIX9D < VIX < VIX3M < VIX6M
Elevated fear: VIX9D > VIX > VIX3M > VIX6M
3 month chart of all 4 time frame volatility indexes
* On stockcharts they are still called VXST, VXV, VXMT
You see those points where the lines start to converge and we see some crossovers? That’s when you’d want to conclude that whatever is spooking the markets, there may be something to it.
We will definitely keep an eye on things today and tomorrow and be ready to move to our safety positions on a single day notice if this turns into something more serious. Safety over everything!
Right now it’s a down day, a tariff announcement day, a frustratingly unnecessary sell off day, but it’s not yet a crossover day.
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