A Top in the Volatility Index Rollercoaster

• Posted by Greg Harmon
• on June 15th, 2016

You have heard it all before. “The Volatility Index ($VIX) is a derivative of a derivative. You can’t analyse a derivative of a derivative on a technical basis.” This is what every expert of the VIX will tell you. Then they will go on to tell you that the VIX trades at a discount Fridays due to the weekend and a premium early Monday. Or that it is overvalued compared to realized volatility.

They are wrong and prove it with their own words. Anything can be analysed from a technical perspective. The study of the price action does not have to fit into any specific narrative. There does not have to be a reason it is doing what it does. But the history does leave clues to analyse for what might happen in the future. And there are clues in the VIX chart right now.

The chart above shows plenty of information about the VIX. Whether you look at the bearish Bat harmonic that led to a reversal in December or the range bound activity from March until last week. But lest focus on the last two days. During the last two days 4 important things happened. First the VIX moved above its long term SMA’s. This had not happened since February. Remember what the market was doing in January and February. It was falling. Next, the VIX moved into an overbought condition on its momentum indicator, RSI. The chart shows that this has happened only 1 time in the last year, at the August low, and it was a sharp spike that fell back quickly.

It also moved out of its Bollinger Bands® Monday. This has happened quite often, over 20 times in the chart. But each time it has remained in this position for only a day or two, sometimes not even a full day. Finally, the long upper shad on the candlestick Tuesday shows the first signs of a top in the latest move. This potential evening star formation suggests that you look for a move lower Wednesday and if it comes confirmation of a top in Volatility.

Will it fall back to the prior range? Maybe. It could also just move sideways, especially with the Brexit vote coming up (did I just add to a narrative?). But it does look like the move higher may be done for now.

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