By Plunging 500-Plus Points, The Dow Fulfilled Its Near-Term Script
How the VIX saw it coming
By Nico Isaac
Mon, 25 Jan 2010 17:30:00 ET Email | Print | RSS Feeds Generated by Elliott Wave International RSS | My Updates
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To paraphrase a famous expression: The only thing stock market bulls have to fear is the complete and total lack of fear itself.
Beyond that, there is an accurate way to quantify the collective level of fear (or lack of fear, for that matter) among market participants: it's called the CBOE Volatility Index (VIX). A rising VIX indicates increasing pessimism; a falling VIX signals mounting optimism.
The VIX reading was one of the indicators that led EWI analysts to publish a bullish outlook for stocks in the period from March-June of 2009, in our Elliott Wave Financial Forecast publications. In March, with U.S. stocks circling the drain of a 12-year abyss, we anticipated a powerful rally that would bring the Dow Industrials to the 10,000 level at minimum, with an accompanying surge in positive sentiment readings.
Here, the June 2009 Financial Forecast brought the bullish picture to life and wrote:
"Our best assessment is that the next [peak] should coincide with an optimism toward stocks that rivals that which was registered near the October 2007 peak. After surging to an all-time high of 89.53 in October... the VIX has been dropping, reflecting a lessening fear of falling stock prices. Odds are that the VIX will fall into the low 20's or possibly even into the teens prior the end of the rally."
A dazzling, ten-month rally to new recovery highs later, and the VIX script had been fulfilled: As the following close-up from the January 2010 Financial Forecast reveals, the volatility index had indeed fallen to the "teens" area cited in the June 2009 issue.
Just as a historically high VIX reading in late 2008-early 2009 signaled a fully saturated pessimism and therefore an approaching bottom in stocks -- a steeply falling VIX reading now exposes a near absence of fear.
In time, the Elliott wave structure, momentum indicators, and Fibonacci time cycles joined the VIX to tip the scales in favor of a downturn. Here, the January 13 Short Term Update stepped up to the plate with this commanding insight:
"The larger and stronger the trend, the better the signal... With respect to the VIX, [the current 16.86 reading is commensurate with] a peak. The odds increase that a "VIX" sell now will lead to a decline that is more than just a few percentage points. This means a trend reversal is fast approaching. A potential stopping range is 10,725-10,740. Once complete, prices swiftly retrace to near its origin, which in this case is 10,263.90 on December 18."
The 500-plus point crash in the Dow that followed speaks to the value of a well-developed technical picture.
As EWI's president Robert Prechter reminds subscribers yet again in his current Elliott Wave Theorist, "... market analysis is still, and always will be, probabilistic." What helps you limit those probabilities are Elliott wave structure, sentiment, momentum, time cycles and confirming price action -- often, with great results.
