Investing with the Moon

Posts Tagged ‘VIX’

Why the VIX is so low and why you shouldn’t worry about it yet

Posted by Danny on July 26, 2017

Markets have worked themselves to new record highs and almost everybody is talking about the VIX index staying below 10 for so long with no signs of wanting to go up anytime soon. This move to new records has come right on time per our LT wave for July, but more on that in my next weekend post when I will also put out the wave for August.

Long term readers of this blog may know that I consider the VIX an indicator with little or no predictive value, as per this post from 2015: Forget the VIX…. Back then traders were also worried about the VIX being too low, but they would wait another 6 months to get any correction worth talking about and by now we are two years later and 30% higher on the Nasdaq.

So why is the VIX so low again? The answer is the same as in 2015: because volatility has been very low in recent months and weeks. Just how low? Well, I use a very simple measure of volatility: the 50 day (or week) average of the True Range expressed as a percentage of the index (or stock price). I call this “ATR%”. Contrary to the classic ATR the ATR% makes it easy to compare current volatility to earlier periods when the stock or index traded at much lower/higher values.

As of y’day the daily ATR% for the S&P 500 dropped to 0.584, it’s lowest level in more than 23 years and only just above the all time low of 0.566 (Jan 1994). This volatility measure may drop to new record lows if markets stay this calm for a couple more days:


The weekly ATR% has also dropped to a very low level of 1.675, which is a 21 year low.


With both daily and weekly ATR% at more than 20 year lows we have a VIX at very low levels too. The VIX is simply predicting the recent past.

And there is more. The S&P 500 hasn’t seen a 2% down week since September 9, 2016. That’s 45 weeks without a move that hurts at least a little bit. Such +40 week episodes have been very rare. I have counted only 8 of them since 1950 for the S&P 500, and another 2 of them if we consider the Dow Industrials from 1900-1950. Here is the complete list:


As you can see, most of those “painless” episodes have come during the long post-WW2 bull market, which ended in the early 70s. The longest painless period still stands at 90 weeks and ended in September 1959. Since the early 70s we have seen only two such 40+ week periods, in 1994 and 1996. And now we are in the third one. The table also shows you what happens after such a 40+ week period comes to end (obviously when the S&P has a >2% down week again). I have calculated the market returns in the subsequent 4 weeks, 12 weeks, 24 weeks, 52 weeks and you can see the results in the right side columns. Contrary to what most traders might expect, that first >2% down week after a long painless period is usually not the beginning of a bigger crash. Far more often than not the market does very well in the next 4 to 12 weeks. The average gain 4 weeks after that first >2% weekly decline is 2.6% and the average gain after 12 weeks is 3.3%. Both are higher than the average 0.65% and 1.95% gains we have historically seen over 4 and 12 week periods.
Looking at 24 weeks we have an average 3.2% gain (versus 3.95% in all periods), so 6 months after that first >2% weekly drop we see an underperformance for the first time. And after 52 weeks we see an average 10% gain (versus 8.7% normally). This is better than average , but this comes on the back of two large gains in 1954-5 and 1996, when there was an annual gain of 30% and 26% respectively. The other 6 painless periods produced weak or average 1 year performance after they ended. But none of those periods ended with a serious crash in the next 12 months. That doesn’t mean it cannot happen of course. But based on those historic examples, the next >2% down week will not be a reason to panic but rather a short term buying opportunity. And that’s why we shouldn’t worry too much about this low VIX yet.

Going back to the ATR% charts I showed earlier on, we can also look how this indicator did on earlier occasions when it was unusually low. Here is the S&P 500 daily ATR% on its all time low in January 1994:


Even though the market did get a 10% correction soon after the record low ATR% on Jan 21st, it climbed to news first in early February on a higher ATR%. And that brief 10% correction gave way to a massive multi-year advance, so that ultra-low volatility (ATR%) was only a short term selling opportunity here.

In early 2007 the daily ATR% again reached ultra-low levels. This is what happened next:


The ATR% was very low for months, reaching a low of 0.68 in February. There was a brief pullback, but a significant bear market was still months away and there were two strong rallies before the big decline started.

The same thing was observed near the 2015 highs. The daily ATR% bottomed in summer 2014, but markets kept climbing until May 2015 before a real correction started (see first chart of this post)

Looking at the weekly ATR% in 2006-2007 we see something similar:


Low ATR% values were reached in early 2006, but that only led to a minor pullback a few months later. Even lower weekly ATR% was seen in Feb 2007 (low of 1.74), but the market would go on to climb to higher peaks without setting new lows in ATR%. The eventual decline started more than 6 months after the ATR% low.

Bottom line: what we see is that bear markets usually do not start from record low volatility levels. The common pattern in major market advances is that a period of very low volatility gives way to higher volatility while the markets keep setting new highs. Some market participants get more nervous in the final stages and that shows as a higher ATR% in the final weeks/months of a long bull market. The real decline usually starts when a long term trendline gives way, as you can see in some of the charts.

PS: If you want to try the ATR% indicator on others indexes or stocks then you can use my script on TradingView: It’s also an easy way to see how the ATR% evolves after the posting of this article.

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Forget the VIX, watch the SKEW

Posted by Danny on April 20, 2015

In the recent weeks I have been recommending to stand aside and stay cautious until the stock market offers a bit more clarity. And it is not as if we have missed much by doing so. Friday’s drop tells us that some caution is warranted at this point. Is it just a one day dip, or the start of a bigger storm? I don’t know, but my indicators are still not looking good. And this week I will add something else to keep an eye on, the SKEW index, that little brother of the widely watched VIX index. But, more on that later on in my post. Let’s start with our weekly look at the Nasdaq chart and see if we can read something in the tea leaves (click image to enlarge it):


The Nasdaq remains stuck within a huge narrowing wedge. A breakout (up or down) will be inevitable sooner or later. The most recent rally in the Nasdaq has petered out just short of its March highs, and now the Earl and MoM indicators are turning down already. The slower Earl2 remains flat near the zero line, so can go either way from here. This is not the kind of setup I want to buy.
Friday’s dip has taken the Nasdaq down to the lower border of the wedge. It may try to hold on for a few more days, but with indicators turning down and a new lunar red period starting later this week, we have an elevated risk for a sudden drop. The 4800 level is still a major support, and below that it would go down to 4700 quickly, with 4550 the next major support.
This doesn’t mean a drop *has* to happen, but it’s just an unattractive risk/reward ratio to be long at this point.


Many people like to watch the VIX index, also known as the “fear index”. Personally, I have never found the VIX to be useful. At the most it is a concurrent indicator, it has no predictive value. Yes, the VIX goes up when there is panic in the market. But the VIX (~fear) being low doesn’t mean the market is going to panic anytime soon. Sometimes the VIX is low (and stays low) because volatility is and stays low.
The VIX has a little brother in the SKEW index, and that one is more interesting to watch. Here is a good introduction on the SKEW. The SKEW index is calculated on the basis of far out of the money options (with average duration of about 30 days), and is specifically designed to measure perceived “tail risk”. E.g. if many investors are afraid that the market may crash, they can buy some protective put options at strike prices that are 10% below the market. Those options are usually inexpensive and in the case of a sudden drop those option can become very profitable bets. If there is a lot of demand for this kind of “crash insurance”, then the premiums of those options rise more than rest of the options spectrum, and that gets reflected in a higher SKEW index. So, basically, when the SKEW is high it tells us that a lot of crash insurance is being bought, and when the SKEW is low it means that investors are buying less insurance (for example because they feel safe that the market will not drop in the next month).

But as my uncle used to say: “In the stock market it never rains when everybody is wearing boots”. The market will rarely crash when “everybody” is loaded up on crash insurance. It would take highly unusual news to create the necessary selling to get a crash. Because the people who have crash insurance do not need to sell (they are protected), and those who sold the crash insurance have no incentive to sell either (because that would be like shooting themselves in the foot on purpose). Crashes are generally caused by (small) investors panicking, and they are less likely to panic if they own crash insurance in the form of out of the money puts.

If we study the history of the SKEW index since the early 1990s we can see that concept in action. Here is a chart showing how the SKEW behaved going into the 2000 market top. (click image to enlarge it):

SKEW 2000

During the 1990s bull market the SKEW averaged around 115. A few brief panics in 1997 and 1998 made investors more aware that the market was becoming risky, so more crash insurance was being bought, lifting the SKEW index above 120 with peaks above 140. Note that this was the equivalent of buying boots after the flood. Most of this crash insurance expired worthless because the market kept rising. So, the good folks who sold those out of the money put options were raking in nice premiums month after month. And the people who bought crash insurance gradually stopped doing it, because it never paid off. A few dips in late 1999 again pushed the SKEW above 120, but lower than at its peaks in 1998. And by early 2000, with the market at record highs the SKEW started dipping below 110, its lowest level in years. For some reason investors stopped buying crash insurance at the top. Perhaps they felt too good. Fear disappeared and complacency took its place. Buying out of the money put options had not worked for years, and investors gave up on it. And when nobody had boots, that’s when it started to rain..

And surprisingly, the SKEW stayed below average for most of the market’s slide into the 2003 lows. People did not buy much crash insurance when it would have paid off. Then as the market recovered and kept climbing in 2003-2006, people started worrying about another crash and they bought more out of the money puts again to be on the safe side. From late 2003 until early 2007 the SKEW index stayed above average with regular spikes above 130. Image (click to enlarge):

SKEW 2005

Of course, once again most of that crash insurance never paid off, because just like 1998-99, the market kept climbing 2004 to 2007. And then the same thing happened in 2007, investors got tired of wasting money on crash insurance that never pays off. And the SKEW index started going down, just when the market was on the verge of crashing (click image to enlarge):

SKEW 2007

By the end of 2007 the SKEW had dropped below its historic average again, and the demand for crash insurance remained low (as evidenced by low SKEW) for most of the slide into the 2009 lows. In August 2008, right before the most dramatic part of the crash, the SKEW was even trading below 110.

After the 2009 lows, investors had once again learned to hedge against tail risk (buying boots after the flood). The SKEW traded above historic average again, as people stayed fearful during the recovery that started in 2010. And then something funny happened (click image to enlarge it):

SKEW 2010

In late 2013 the SKEW started trading at even higher levels, with occasional spikes above 140. That hasn’t happened before. Apparently, with the market at new record highs, plenty of people became convinced that a crash was coming again. Having seen big losses twice in the recent decade, many traders may have been determined to not get caught in the next crash without insurance. Fear ruled, despite record highs. But once again, all those premiums paid for out of the money put options have only been profits in the pockets of those who sell those options. The market has kept going up in 2014.
But since the beginning of 2015 we suddenly see a strong downtrend in the SKEW. This is the first sign that we may be getting into a new stage of complacency. Markets are at record highs (just like in 2000 and 2007) and the SKEW drops to lows suggesting that crash insurance is no longer in vogue. That can be a deadly combination, so we want to keep an eye on the SKEW. And if it goes on to drop to 110 for extended periods, then we will know it is that time again.

Good luck,


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Is investors’ money where their mouth is?

Posted by Danny on April 2, 2013

It is well known that moods, fear and greed drive the markets. So a number of “sentiment” indicators have been developed over the years, in an attempt to measure the mood of the market.
There are indices like the VIX, which try to measure fear or greed on the basis of option premiums.
Other sentiment indicators are based on weekly or even daily polls.

But the problem with the latter is that we don’t know whether the polled investors have acted on their own feeling. An investor might feel mildly bearish, but that doesn’t mean he has sold already. Another investor might be bullish, but maybe he is still waiting for a pullback to do his buying..
Another problem is that not every investor is swinging an equal sized portfolio. A small retail investor might have $20,000 in his account, while a larger investor may have a few million to work with. Both will be getting one vote in the investor sentiment poll, but clearly their influence in the market is of a different magnitude.

It would be a lot better if we could measure whether investors are putting their money where their mouth is. But how to do that?

A few years ago I discovered that Interactive Brokers is publishing their brokerage metrics every month. See:
Every month they tell us how much equity and how much margin debt their customer have. So it’s easy to calculate margin debt as a % of equity. That’s what I did and this is the resulting chart (click for larger image):

brokerage metrics

What does this chart tell us? Well, we would expect to see investors take more risk (more margin debt) when they are bullish and optimistic, while reducing their risk when they are bearish. Indeed, we see that margin debt bottomed at 15% during the 2008 financial crisis. It was lowest in October, well before the market finally bottomed out in March 2009. This means that Interactive Brokers customers were buying at the bottom. We also see that margin debt peaked out at 40% in April 2011 and has since come down to more average levels, even though the market has continued to go to new highs.

Interactive Brokers typically serves more experienced investors who trade frequently and want access to a lot of different markets worldwide. Their average customer has about $170,000 in his account.
While it is good to see what the somewhat more sophisticated clients of IB are doing, it would be even more interesting if we could see the same data from brokers that serve the small retail investor.
While I haven’t found such data, TD Ameritrade took an interesting step last January when they introduced their “Investor Movement Index” (IMX). You can find it here:, and this is their current chart (click for larger image):

IMX by TD Ameritrade

(source: TD Ameritrade)

This index claims to be based on their customers market exposure and activity, but as we can see, the peaks and bottoms in their IMX (green line) seems to lag the highs and lows in the market (grey line) by one or two months. Which should not surprise, since TD Ameritrade is popular with small retail investor, who have an average $100,000 in their account. Small retail investors have a history of being late to the party, and this chart tells us that small investors are getting rather optimistic right now.
It also gets interesting when we see divergences between what IB clients are doing and what this IMX indicates.
For example, while the IMX made its largest one month gain in February, the IB clients have slightly reduced their exposure to the market since last January.
This suggests that distribution of stocks to the broader public is underway, and that’s a warning sign.
Distribution can go on for a while, but the longer it lasts the more painful it ends.

So, I am keeping an eye on both these indicators and will keep you up to date via this blog.


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