Gordon Gecko is famous for uttering the phrase, “Greed is good.”

From a stock market perspective, however, I’d like to turn that phrase on its head and say, “Fear is good.”

And here’s why: when you take a look at the historical relationship between the stock market and heightened periods of fear (which can be approximated by using the VIX, a measure of the implied volatility of S&P 500 options), high periods of fear have tended to coincide with lows in the stock market.

Here’s a chart going back to 1993 that plots the S&P 500 (on top) and the VIX (on the bottom). You’ll see that when the VIX spiked, it tended to coincide with lows for the market (except 2008, when the market’s back was broken and it took longer for a low to be established):

(Click to expand)

What we want to look for in a bottom is a spike in the VIX that’s accompanied by extraordinarily high volume. With Monday’s price action, we got just that: a spike in the RSI (relative strength of the VIX, approximated by VXX, and compared to the SPY) that exceeded the 80 barrier with volume levels not seen in years. Look at the highlighted ellipses below:

(Click to expand)

The last time we had something just like this happen was 8/8/2011, the day the U.S. lost its AAA credit rating by S&P. Back then, it signaled a short term bottom, with the market jumping 4.6% the following day, but then it took a 4.4% hit the day after that, and another jump of 4.5% the day after that.

So if history is any guide, it’s saying we have the ingredients for a short term bottom, but it’s going to bump around massively over the next few weeks at these levels.

(Posted 8/24/15)

Rainier Trinidad, CFA
San Diego and Coronado’s Fiduciary Financial Advisor
Parabolic Asset Management
206 J Avenue
Coronado, CA 92118
rainier@parabolic.us
(619) 888-4070
Investment Risk Disclaimers: (i) Investments involve risk and are not guaranteed to appreciate, and (ii) Past performance is no guarantee of future results.