Thursday, December 03, 2009

A Megaphone Announcing Extremes of Sentiment and Indecision

A huge "megaphone" pattern in the "fear index" (VIX) presages a major break up or down as extremes in sentiment and indecision will soon resolve one way or the other.

I've missed the past dozen or so news cycles and have only looked at a few charts in the past two weeks. This one of the VIX really popped out: a big fat megaphone. Before I post the chart, please read the HUGE GIANT BIG FAT DISCLAIMER below to refresh your awareness that this is not investment advice but merely the freely offered musings of an amateur.

OK, here's the chart:

Megaphone patterns can be interpreted various ways, but what is obvious is the lower lows and higher highs--rising extremes in both directions which suggest a rapidly escalating tug of war between bulls and bears.

Now the VIX is not a stock or an index of stocks (or an ETF)--it is a measure of volatility based on the options being traded, presumably for "protection" against a major decline.

So what's visible here are rising extremes--new lows in the VIX suggest complacency and confidence, while higher highs suggest increasing fear and "itchy trigger fingers" of traders seeking protection at the first hint of decline.

Both can't be right. This chart suggests a great indecision plagues the minds and emotions of traders and speculators. Either the market is stable and rising confidently, and the VIX will settle lower without experiencing these wild spikes of high volatility, or the market will start falling and the VIX will rise without plummeting a few days later to new lows.

One way or the other, this megaphone will be resolved, and the same can be said of the stock market which the VIX reflects: the megaphone will break up or down, and so will the stock market.

As the dollar (DXY) plumbs recent lows and the entire world seems to be betting on further declines in the DXY, we might ponder the facts that 1) no trend lasts forever and 2) the seesaw between the dollar falling and the market rising suggests a rise in the dollar--when and if it comes--will be catastrophic for the 9-month old stock market rally.

The VIX is shouting "caution!" through a megaphone, at least to those willing to listen.

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