Key Index Signals Going Cold In Market Volatility

2022-02-23

The market has consolidated into a collection of bearish signals in what feels like an indefinite chop fest — not exactly the launch into the new year that Simpler’s traders expected.

Simpler’s traders are spending extra hours reviewing their indicators to seek out patterns in this market insanity. Finding the outperformers and the underperformers in the indices provides guidance to trading setups in this uncertain market.

Focus is on two key areas of index signals

Two areas of focus for the Simpler Trading team are the Chicago Board Options Exchange CBOE Volatility Index (VIX) and the S&P 500 index signals

The team is watching the VIX (often considered an indicator of fear in the market) for a pattern of higher lows and higher highs, along with trend structure, possibly revealing a push into higher territory

What does this mean? The increased VIX volatility is not a positive signal for the entire market.

The U.S. equity market volatility can be traded like an asset class by following the VIX. This benchmark index measures market expectation of future volatility and is considered the leading indicator of the broader U.S. stock market.

The S&P 500 has shown evidence of damage structurally and to momentum in the index due to market chop. Simpler’s traders have taken opportunities to short the index as it dropped followed by a bounce that didn’t hold. There are also signals that indicate there are more lows to come.

The S&P 500 can be used as a proxy for the entire market since it is showing a better structure than the other major indices (Nasdaq and Dow). If the S&P 500 breaks, the weaker indices will likely follow its lead.

Watching divergence showing price instability

Keep in mind that when prices increase, but momentum decreases, the resulting divergence creates an enormous amount of instability in price. This is when Simpler’s traders proceed with caution.

The VIX and the S&P 500 have recently shown two very different setups — with the VIX trending higher and the S&P 500 trending lower. Simpler’s traders anticipate this same story to repeatedly play out this way for some time.

What are positive signals vs. downward trend?

There are a few areas of the market that are moving against the downward trend. While there aren’t many, energy stocks show promise. Companies in the material and financial sectors are generally strong players in this environment.

What sectors do Simpler’s traders avoid in a market such as this one?

Just like a flamingo in Alaska, small caps and technology are not suited for this weather — and traders may do well to go elsewhere.