Welcome to the wild and wacky world of trading…where the fate of the financial markets is often determined by itchy twitter fingers. Remarkably, the Dow has dropped approximately 1,500 points since President Trump’s tweet on Thursday.
And while the futures are trading higher this morning… we can not ignore the damage that was done yesterday— S&P 500 diving below its critical moving averages (the 50-day and 100-day).
Make no mistake about it. Yesterday was the worst day stocks have seen all year (Dow -2.89%, S&P 500 -2.98%, Nasdaq -3.47%, and Russell -3.02%)…
The reason for the selloff yesterday?
China allowed its currency to weaken to levels it hasn’t seen since the global financial crisis.
With so much going on between the U.S. and China, as well as the Fed and corporate earnings… the CBOE Volatility Index ($VIX) rose by more than 30% yesterday… However, this can actually provide us with many trading opportunities.
You see, it’s actually very easy to spot swings in volatility if you know what you’re looking for… and you can make money off shifts in trends.
Find out below.
Well, let’s look at some of the similar moves that the $VIX has had in the past.
Here’s a look at what the $VIX has been doing…
… and here’s a look at $VVIX (which measures the volatility of the $VIX).
Notice something here?
There are key levels in the $VVIX to watch with $VIX.
If you look at the chart above, you’ll notice once $VVIX gets close to 120… we see a sharp pullback in volatility.
Well, markets typically don’t stay volatile for too long because at some point… traders get used to large swings in the S&P 500 Index… or they see sell-offs as buying opportunities, bidding the prices of stocks up… which leads to a drop in volatility.
With that being said, let’s compare yesterday’s bloodbath to some bloodbaths we’ve seen recently… so we know how to prepare for the next move in volatility… whether it continues higher or gets crushed.
$VIX Spikes 36.43% on October 10, 2018
The last time $VIX moved over 30%… it was due to fears of escalating tensions between U.S. and China, as well as rising bond yields.
If you look at the move that $VIX had during that time… it looks very similar to what we saw yesterday.
Here, you have $VIX moving up multiple days in a row (we saw this last week and yesterday)… but it actually pulled back shortly after.
If you were able to spot the signal… then you could’ve made money on a short volatility play, such as buying puts in the volatility tracking exchange-traded note (ETN) – VXX.
So what was the signal here?
The $VVIX breaking well above 120.
Generally, when the $VVIX gets above 120… it’s an extreme level, and what you typically see is a sharp pullback and a quick drop below that key level… and $VIX pulls back.
This is very typical of $VVIX and $VIX… a sharp move higher for a few days… followed by a quick drop.
For example, we saw the $VIX have a massive move back in 2018… which actually caused an inverse leveraged volatility ETN (XIV) to go defunct… that day, the $VIX moved a whopping 76.82%, and it was all due to bond yields rising to levels they haven’t seen since 2014.
What We Can Learn from the 76.82% Move in $VIX on Feb. 5, 2018
Here’s a look at the massive move the $VIX had back in February 2018.
As you can see in the chart above, large moves in the $VIX are followed by massive pullbacks.
With $VVIX, it can stay above extreme points for a few days. For example, with this move, it took 8 days before $VVIX fell below 120.
However, you still could’ve made money if you decided to place a short volatility bet when $VVIX broke above 200 (that’s a really extreme level, which was actually the highest $VVIX has ever been).
Prior to that, the $VIX moved 36.72% on August 10, 2017… and following the same idea of watching $VVIX with $VIX… you could’ve made money if you knew about the signal.
Profiting Off Sharp Drops in Volatility After 30%+ Moves
Now, back in August 2017, the volatility was attributed to geopolitical tensions between the U.S. and North Korea.
Here’s a look at the $VIX when it had a massive spike.
If you look at the daily chart above… we saw a massive move higher one day…$VIX tried to continue the trend higher… only to gap down and fall max to normal levels.
Again, to spot the shifts in volatility… you would also look at the $VVIX.
As you can see, $VVIX only stayed above 120 for 2 days before breaking well below that key level.
So how does this help us today?
Well, we saw $VIX spike 33.39% yesterday… but the $VVIX is not quite near 120 yet… however, it’s getting close to that level.
What I’m also watching in the $VIX is my money pattern. Basically, I’m waiting for two lines to cross to signal a shift in the overall trend in $VIX before I place any bets on the market or volatility.
For now, I’m going to remain patient because it’s a very emotional time for traders right now… and they may be making moves with no rationale behind them… and that’s when things can get real ugly.
However, volatile markets are some of my favorite times to trade… because that’s when I can make the most money. If you want to actually make money during bloodbaths, you’ll want to check out this video of real-money case studies and learn strategies to navigate the markets when stocks are crashing.