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The author looks at the Vix indicator and its use in predicting the market turn of 2002.

In the last 2 weeks, I have seen the “VIX” on both CNBC and Bloomberg TV talked about as if it was something new. Well, for all you OTA Grads, you know we have been using it for years. For the rest, let’s review and see how this "new" indicator can help us.

Let's look back at the turn in the markets in 2002.

The VIX is provided by the Chicago Board of Options Exchange (CBOE) and, basically, measures the volatility in the options markets, which of course, are directly related to the underlying security in the stock market. VIX (generally, you can see this with the VIX symbol, but your platform may require a prefix or suffix such as $vix, /vix, vix.x, .vix or even ^vix. Each has it own requirements. Pretty much, whatever you use to see the Standard & Poor's 500 Index <SPX>, VIX will follow that format).

As volume, velocity and directional change start to go up in intensity, we measure this as “volatility”. Historically, we see that when this range is under 36 points (nominally 20 – 35), the market is fairly calm and happy in its trend – up or down. However, when the VIX starts to move above the “36” line we start noting historical changes.

Here’s a 4 year, daily chart of the VIX. I have drawn in the blue “36” line. You can immediately see some changes in the market at the breakouts.

Lets look at some past data; at (1) Sept/Oct of 1998 – the Naz and Dow had been rallying all year long. In late spring, whispers of the “Asian Contagion” were going around. Would Japan recover or would their economy slip further into recession/depression? The market started to wobble. It hates uncertainty. As July blended into August, we found that Russia was defaulting on some IMF loans. So we had the “flu” and a monetary meltdown. The market reacted violently in Sept/Oct. It was a vicious drop from the 2000’s on Naz to the 1400’s.

VIX started peaking above 36 in the end of August and you can see that by Oct it was screaming above it. It was clearly signaling the turn in the market. Things were too crazy to the down side, it had to turn around. Once the “washout” was over, the markets recovered and you can see that by late Oct, VIX had dropped back to normal. The downward plunge was over, and the Naz started to re-establish its up trend.

Here's a larger view of (1).

At (2) we see the VIX get above 36 and actually into the mid 40’s in Mar/Apr of 2000 – Hey, did anything happen then? What Tech Bubble?