Always keep an eye on volatility.
When the market swan dives, as it did recently, volatility as measured by the Volatility Index (VXX) rockets higher. When the market recovers as it’s beginning to do, volatility snaps back, and begins to revert to mean.
Unbelievably, it’s quite predictable. Watch.
We can spot when the bulls or bears have gotten ahead of themselves. We can tell when things will fall apart, as the herd makes a mess just by watching our usual pivot points.
When the Dow gets far too stretched, RSI tops out above its 70-line. MACD spikes. And MFI tops out and reverses lower. It tells us the market is about to come down.
Look at the December 2014 top, for example. RSI topped out above 70. MACD sat at 200. And MFI was already reversing from 80. We were over-extended all these indicators. We saw similar sell offs in May 2013, July 2013, September 2013, January 2014, August 2014, and again now.
Each time those sell offs happened, the VIX popped, as it should have.
Now look at what happens when RSI, MACD and MFI alone bottom out. The market begins to recover. And as the market begins to recover, volatility comes screaming back to earth.
Today, after an 800-point swan dive marked by overbought RSI, MACD and over-extended Money Flow (MFI), the Dow just found a new base t the 50-day moving average with now oversold RSI and MACD.
There are two very simple ways to profit from volatility over-extensions. One, you can always buy a put option on the VIX, but we prefer to use the iPath S&P 500 VIX Futures ETN (VXX) because it has historically provided us with great returns.
Consider buying to open the VXX March 2015 32 put up to $6.
And or two, you can always buy or short the Velocity Shares Daily Inverse VIX ETN (XIV) which travels in the opposite direction of the VIX. Consider buying the XIV up to $31.
As long as you can identify these trends, you stand to do incredibly well.
Happy holidays to you and your families… and have a happy, healthy, profitable New Year.
Ian L. Cooper
Inside Value Trader