Daily Sentiment Index Extreme Says Volatility Is Next

Why You Should Expect a Pickup in Stock-Market Volatility
“Traders are convinced the market volatility will remain subdued”

When things get quiet in a horror movie, that’s when you need to really brace yourself. The monster or the killer will soon be on the scene.

That’s a close enough analogy to what can happen in the stock market. Just when investors get comfortable with a stretch of low volatility — wham! — volatility picks up in a major way.

Back on Nov. 27, 2019, our U.S. Short Term Update, a thrice weekly Elliott Wave International publication which provides near-term forecasts for major U.S. financial markets, showed a chart titled “Calm Before the Craziness,” and said:

The CBOE volatility Index (VIX) closed below 12.00 for the third straight session… In fact, investors are so complacent that, paradoxically, it signals a coming pick up in volatility.

About three months later, our Feb. 24, 2020 U.S. Short Term Update noted:

The VIX surged 69% intraday and is now up 130% since the November 26 low. The VIX should eventually move even higher as stocks prices work lower.

As you may recall, a hair-raising stock market decline that had started in mid-February continued to plummet into March 23 of that year.

What does this have to do with today?

This chart and commentary from our August 15, 2022 U.S. Short Term Update provides the answer:

VolatilityPickup

We have inverted the scale to align the VIX with prices. The DSI Indicator (trade-futures.com) has declined to 15, the lowest reading since March 29 (DSI of 13), which coincided with [an Elliott wave high]. The VIX itself declined to 19.12 on August 12 and traders are convinced the market volatility will remain subdued. As shown by the vertical dashed lines, the prior two times that traders were equally confident that volatility will remain muted occurred at or near prior market highs.

Indeed, an August Yahoo Finance headline reflects an example of this confidence:

10 reasons to be bullish on stocks right now, according to [a strategist at the largest U.S. bank]

That strategist may turn out to be correct.

On the other hand, volatility has already picked up since our August 15 analysis published. Of course, during periods of high volatility, there’s the potential for big moves on the up- as well as downside.

Now it’s time to learn what the Elliott wave pattern of the stock market is suggesting.

If you’re new to Elliott wave analysis or need a refresher, you may want to read Elliott Wave Principle: Key to Market Behavior by Frost & Prechter. Here’s a quote from the book:

It is a thrilling experience to pinpoint a turn, and the Wave Principle is the only approach that can occasionally provide the opportunity to do so.

The ability to identify such junctures is remarkable enough, but the Wave Principle is the only method of analysis that also provides guidelines for forecasting.

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