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I'm a VIX "traditionalist," whatever in the world that means. I believe in the power of mean reversion, so I look at it as a contra-tell when the CBOE Market Volatility Index (VIX) moves too far one way or another -- to determine "too far," I use 20% deviations on other side of the 10-day simple moving average. That particular number is not gospel; you can clearly reduce it and generate more signals. I, however, prefer to keep it wide.

I bring this up because we just had a pretty rare reversal. In fact, by this metric, it's the fastest VIX reversal based on numbers that go back to January 1990 (incidentally, that's before they invented the VIX -- pre-1993 numbers are back-calculated).

How unusual is this? I could only find four other instances in the last 23 years where VIX reversed -- from 20% above the 10-day to 20% below -- within a month.

  • On 10/27/08, VIX closed 20.4% above the 10-day, then dropped 40.3% to close 27.4% below on 11/4/08, six sessions later.
  • On 8/15/07, VIX closed 21.5% above the 10-day, then dropped 32.4% to close 21.4% below on 8/24/07, seven sessions later.
  • On 7/23/02, VIX closed 22% above the 10-day, then dropped 34.5 to close 21.2% below on 8/15/02, 17 sessions later.
  • On 1/14/91, VIX closed 20.3% above the 10-day, then dropped 32.8% to close 21.6% below on 1/21/91, five sessions later.

Now of course, there's some self-fulfilling prophecy to it all. If the VIX reverses quickly off overbought, the 10-day will still be lifting while the VIX itself is falling. So it does set up a situation where you can see flips like this.

That being said, though, it has only happened five times in 23 years, so it's quirky and unusual.

The important question is whether it means anything for the market.

Well, in 2008 it had a pretty unhappy ending. The SPDR S&P 500 ETF Trust (SPY) dropped 10.6% in the week after the VIX reversal. Twelve sessions later, the SPY had dropped 25%, all the way down to $75.45. Which (in hindsight) was the buying opportunity of the millennium. But initially, shorting the market on the oversold VIX was a huge winner.

On the other hand, the market did just fine off the oversold VIX in August 2007. The SPY was up fractionally a week later, and about 3% higher three weeks later.

The 2002 oversold VIX saw very mixed performance. Within one week, the SPY had rallied 3%, but three weeks out, the SPY was down 5%.

It's too small a sample size to make any definitive judgments. But it's important to note that the 2008 move in VIX was a counter-trend drop in the middle of a huge VIX explosion in the ugliest year in a generation. The 2002 VIX move was also off a bounce in an ugly market. Neither of which describes our current backdrop. The counter-trend move was the VIX pop that led into the drop.

My guess is we'll look back at Friday's VIX as a non-signal -- more like the 2007 reversal.

Disclaimer: The views represented on this blog are those of the individual author's only, and do not necessarily represent the views of Schaeffer's Investment Research.

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