Beyond VIX: Should Traders Fear Fear Itself?

The CBOE Volatility Index (VIX) is just one of many "fear gauges"

by Adam Warner

Published on Jun 11, 2015 at 9:08 AM

The CBOE Volatility Index (VIX) is called the “fear index” by just about everybody, so it’s easy to forget that it’s merely one way to gauge fear among countless others. Fortunately, CNN quantifies several into their own proprietary Fear & Greed Index.

We were at “Fear” before yesterday’s blast-off, but still a bit above “Extreme Fear.” I’d view this as a contrary indicator, but these sort of sentiment tells are tough market-timing tools. As we know too well, extreme fear can beget really extreme fear before it finally turns. We hit the 90s about this time last year, and in hindsight, that was a good sell signal -- although it took another month or so before that played out.

Our level of “fear” now seems pretty appropriate. The market rotated between churn and downright ugly in recent weeks, so a bit of apprehension seems warranted. So, the actual level of the overall index doesn’t tell us much. The breakdown of how CNN gets there is more interesting.

The index contains two options indicators. One is based on put/call volume; the other is based on VIX and its 50-day moving average. CNN rates both of these “neutral,” which I can see surprising people on both sides of the VIX debate. Half see us in some sort of volatility pop that doesn’t quite exist yet, whereas others see the absolute level of VIX as rather low. I guess, given that debate, neutral is about right. I’d throw in that VIX is pretty neutral vs. realized volatility, and VIX futures are neutral in that they’re in their permanent overbid in the out months.

So, where’s the fear showing up? CNN highlights three spots:  

"Stock Price Strength: The number of stocks hitting 52-week highs slightly exceeds the number hitting lows but is at the lower end of its range, indicating extreme fear...

"Stock Price Breadth: The McClellan Volume Summation Index measures advancing and declining volume on the NYSE. During the last month, approximately 11.35% more of each day’s volume has traded in declining issues than in advancing issues, pushing this indicator towards the lower end of its range for the last two years...

"Market Momentum: The S&P 500 is slightly above its 125-day average. During the last two years, the S&P 500 index has often been further above its 125-day average than it currently is, so declines like this indicate extreme fear."

I could make the case the latter is more of a support/resistance line than anything else. The market has clearly stalled, but as you can see on CNN's chart, it’s bounced off the 125-day MA a few times in this run. We’ll see if that happens again.

The first two are more worrisome, though. Declining breadth is never a good sign; it suggests that there is more pain out there than the rather tame basic indices would suggest. Ironically, sputtering Apple Inc. (NASDAQ:AAPL) could help that picture. It’s such a large component of the indices that breadth might start looking relatively better if there’s a flow of cash out of AAPL and into ... not Apple. All in all, it’s some sluggish numbers behind some sluggish market days.

Disclaimer: Mr. Warner’s opinions expressed above do not necessarily represent the views of Schaeffer’s Investment Research

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