Gauging Fear in the Markets: Put/Call Ratio and Volatility Index (VIX) ~ market folly

Wednesday, September 17, 2008

Gauging Fear in the Markets: Put/Call Ratio and Volatility Index (VIX)

Two fear gauges many people use in the markets are the Volatility Index (VIX) and the Put/Call Ratio. And, both are getting close to levels that historically signal the intense fear in the markets we've seemingly been waiting forever for. Why are we waiting for such fear? Because it typically marks an opportunity.

First, my man Stewie has a great Put/Call chart up illustrating the historical levels of the ratio. As the ratio reaches 1.20, you can see that it has coincided with market lows/tradeable bottoms. So, while the market is down big and there is some level of fear... there is no true panic yet. The assumption would be that we are well on our way to true panic and levels of 1.20 on the Put/Call Ratio. If this becomes the case, I would look to start buying a few names for a trade at the very least. Don't ya just love buying when there's blood in the streets? As the chart illustrates, those levels on the ratio have marked tradeable bottoms (but not THE bottom). This is pure chart candy right here:

(click to enlarge)

Secondly, VitalTrends has the historical Volatility Index (VIX) chart posted up for us. Typically, as the VIX blasts past 30, a strong level or fear sets in. And, once you get as high as 35-37, panic and capitulation often occurs. Now, that's not to say that we could always go even higher on the VIX and reach even new levels of fear. But, historically, a VIX of around 37 has been a tradeable bottom as it marked intense fear and capitulation. If you were to overlay this chart with a chart of the market, you would find that those spikes in the VIX would coincide with tradeable bottoms in the market (but not THE bottom).
(click to enlarge)

The point of gauging fear? Opportunity. Should panic truly set in, we should have a very tradeable bottom on our hands (emphasis on 'tradeable,' as this is not THE bottom). We'll see what happens.

Sources: Stewie and VitalTrends

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