“Be greedy when others are fearful”, Warren Buffet famously said. In our experience, it is wise counsel – if you have the intestinal fortitude to implement such an approach. The key, of course, is how to reliably measure fear. That is, how do you know when fear is elevated enough to be greedy? It is not necessarily a straightforward task as there are countless ways of measuring investor fear, and over various durations. In this post, we highlight one volatility-based indicator that is signaling elevated levels of fear in the short-term. But is it enough evidence for traders to get greedy – or is it a sign that volatility is on the rise?
The indicator is the short-term S&P 500 Volatility Index, or VXST. It is just like the VIX, but it measures volatility expectations over the next 9 days as opposed to the next month. Monday (3/19/201), amid the Facebook-led selloff, we saw the VXST put in one of its sharpest spikes of all-time, at least on an intraday basis. At its high, the VXST hit a high of 29.09, a gain of 95% from the prior day’s close. It ended the day off of its highs, closing up by 47%. But that intraday spike nearly marked only the 5th occasion since the VXST inception in 2011 in which it doubled its prior day’s closing price at its intraday high.
So did this VXST spike constitute a buy signal, at least in the near-term? With just 4 historical precedents, it’s difficult to make a determination off of this one data point. Expanding the parameters to look at other large VXST spikes (instead of just “doubles”), we see that sometimes they occurred at the beginning of corrections and opened a path to a higher volatility environment. At other times, however, they closely marked the end of selloffs.
Did this recent spike signal enough fear to begin being greedy again? Or are we headed into an elevated volatility environment for some time? In a Premium Post at The Lyons Share, we break down the VXST spike data further and come to a determination about whether we should get greedy now or buckle up for more volatility.
The ProShares Trust Ultra VIX Short Term Futures ETF (UVXY) rose $0.81 (+5.20%) in premarket trading Thursday. Year-to-date, UVXY has gained 52.69%, versus a 1.34% rise in the benchmark S&P 500 index during the same period.
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Disclaimer: JLFMI’s actual investment decisions are based on our proprietary models. The conclusions based on the study in this letter may or may not be consistent with JLFMI’s actual investment posture at any given time. Additionally, the commentary provided here is for informational purposes only and should not be taken as a recommendation to invest in any specific securities or according to any specific methodologies. Proper due diligence should be performed before investing in any investment vehicle. There is a risk of loss involved in all investments.
This article is brought to you courtesy of Dana Lyons, JLFMI and My401kPro.