Trader’s Narrative

In a recent article, Mark Hulbert talks about the volatility index and mentions Samuel Eisenstadt a research director at Value Line who says that the current volatility readings don’t really tells us anything useful because the VIX isn’t high enough. Hulbert concludes:

The bottom line? Upon learning that the VIX is currently 26.57, we know next to nothing more than we knew before.

Which while true, proves that all models and all calculations provide answers which are constrained by the (usually unsaid) assumptions built into them.

The mistake that Eisenstadt makes is to look at the nominal value of the VIX - 26.57 or whatever it is at the moment. A cursory glance at the long term data shows that volatility can rise and crest at different levels. At one period in time 40 is “high” at another “80″ is the new “40″. If we insist on only looking at the nominal number we miss out on the real insight that data can provide.

To really understand where volatility stands we have to iron out the current zietgeist it finds itself in. To do that we can simply look at it relative to its 50 day moving average. Any moving average would work. I just like 50 as a nice round number - not too large, not too small. I’ve already shown you a three year chart of this.

Below you can see a long term (from 1998 to present) chart of the distance of the volatility index from its own 50 day moving average. I haven’t bothered to put up a chart of the S&P 500 index underneath the volatility chart because it should be obvious to any casual student of the market that all of the significant spikes correspond to important market bottoms.

Looking at the VIX this way shows us that right now we are indeed witnessing an event which in the past has reliably accompanied inflection points.

Click To Enlarge Graph: