This is an old and trusted buy signal that almost every seasoned trader knows about. Seeing as the market has made a huge gap down this morning, I thought it to be appropriate to show how I plan on playing this sell-off if it decides to continue.
I’m now out of all my long positions. I took some profits in PCYC, RSH, LOCK and stopped out on GLUU and ZNGA. Overall I saw much of my profits from yesterday’s morning run up evaporate, but still it’s been a winning week. The big red reversal candle sure spooked many traders, myself included. However the market has been quite resilient, so it is smart to watch and be ready to jump on when a recovery occurs. A good trader must be opportunistic, and I believe the VIX signal is a great tool for knowing when it is a good time to be exposed on the long side again.
So here is how it works. When the market sells-off, there is elevated fear in the markets. This is why the VIX is often called the “fear index” and this is what the VIX measures, the premium that is placed on put options. The VIX usually moves opposite the SPX and when it spikes, this often signals bottoms in the market. Here is one way that you can play off these spikes.
1. Set up your VIX chart with the default Bollinger band study.
2. Wait for the VIX to spike above the upper Bollinger band.
3. Watch to see if the VIX can close above the Bollinger band for a 2nd consecutive day. This is a requirement to have 2 consecutive closes above the upper Bollinger band, one is not enough.
4. On the 3rd day, if the VIX closes back within the Bollinger Bands, this is your trigger to go long. You can either buy an index ETF, go long some stocks of your choice that are setting up, basically this is a good place to get exposed to the long side again.
5. In the below chart for example, I bought the XIV, which is the inverse VIX ETF. This is an intraday chart which shows my entry point for this trade. Although for this signal to work, it requires a close within the Bollinger Bands, you can sometimes take a risk and enter early if the VIX makes a big gap down like in this instance.
Today at the open, the VIX is above the upper Bollinger band. I’ll be watching to see where it closes today and tomorrow which could set up a possible buy signal early next week.