The VIX indicator

Bernie Schaeffer\'s observation of the volatility indicator 9/24/07
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With the rate-cut mystery solved for the time being, we\'re now left to sort through conjecture on the two remaining meetings of 2007, the market can earnestly continue the recovery from its August nadir, which was defined by climactic pessimism. Weeks later, this pessimism continues to unwind, as exemplified by the price action of the CBOE Market Volatility Index (VIX). Last week, the fear barometer declined nearly 24% and closed below its 80-day moving average, as well as its mid-March peak (21.25).

What\'s more, the VIX ended Friday beneath its 20-week moving average for the first time since April 20. Intrigued by this behavior, our quantitative analysis group looked back 10 years to see the short-term implications of a drop by the VIX below the 20-week average, after a period of 10 weeks or more north of this trendline. Since 1998, this particular phenomenon has occurred only seven times, and each time, it has enjoyed bullish implications. In fact, the returns are quite good when compared to the market at any given time, and the signal has been consistent (the standard deviation of the returns are lower than that of the market in general). For example, the last time the VIX made such a move was May 13, 2005--and the SPX gained a respectable 4.05% during the next 20 trading days, while the average gain in the index during a 20-day period is only .45%.

Speaking of signals, I\'d like to briefly follow up on one that was generated late last month. On occasions where the VIX jumps 50% and then shifts back below its 20-day trendline, the market has been higher almost 95% of the time one month after such an occurrence. This bullish signal was triggered Aug. 22, when the SPX closed at 1,464.07. One month later, September 21, the SPX closed at 1,525.75, up 3.7%.

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http://www.forbes.com/2007/09/24/volatility-vix-lennar-pf-ii-in_bs_0924outlook_inl.html?partner=yahootix