Oversold Volatility Setups

Blue chip averages closed on a strong note Monday, with the S&P500 gaining
over 1% and doubling the performance of the NASDAQ. Advancing issues
outnumbered decliners by over a 3:1 margin on the NYSE and advancing volume
accounted for over 80% of total volume. Tech stocks noticeably underperformed
despite 2:1 positive breadth on the NASDAQ exchange. The Nasdaq Volatility
Index (VXN) closed higher Monday, bucking the 4% drop for the VIX and 9%+ drop
for the VXO. That sharp drop in the VXO left the index in statistically
oversold territory, a generally negative sign for the short-term.

We chart the VXO with standard bollinger bands in order to identify overbought
and oversold periods. Unlike times of rising volatility, in which the VXO can
remain over it's upper band for a number of days before correcting, volatility
generally won't remain in oversold territory for more than a couple of
sessions before rallying. Given the inverse relationship between volatility
and the stock market, rebounding volatility should correspond with a weak
market. Listed below are all recent occurrences when the VXO closed under it's
lower band, indicating volatility is technically oversold, along with the
performance of the OEX over the next three sessions...

VXO Closes Under its Lower Bollinger Band
02/25/08... OEX ??? three sessions later
12/21/07... OEX -0.5% three sessions later
09/21/07... OEX +0.1% three sessions later
11/17/06... OEX +0.2% three sessions later
08/16/06... OEX +0.5% three sessions later
11/03/05... OEX +0.1% three sessions later
09/09/05... OEX -1.1% three sessions later
06/21/05... OEX -1.9% three sessions later
04/12/05... OEX -3.2% three sessions later
02/04/05... OEX -0.5% three sessions later
02/01/05... OEX +1.2% three sessions later (*)
12/21/04... OEX +0.1% three sessions later
06/08/04... OEX -1.2% three sessions later
07/25/03... OEX -1.1% three sessions later
05/16/03... OEX -2.2% three sessions later
04/17/03... OEX +3.0% three sessions later (*)
04/14/03... OEX +0.9% three sessions later
11/20/02... OEX +2.1% three sessions later (*)
11/15/02... OEX +0.7% three sessions later
12/27/01... OEX -0.3% three sessions later
12/19/01... OEX -0.6% three sessions later
10/26/01... OEX -4.2% three sessions later
05/21/01... OEX -1.5% three sessions later
01/23/01... OEX -0.4% three sessions later
08/08/00... OEX -0.2% three sessions later
06/29/00... OEX +0.5% three sessions later
11/18/99... OEX -0.4% three sessions later
10/08/99... OEX -3.9% three sessions later
06/04/99... OEX -0.8% three sessions later
03/05/99... OEX +0.9% three sessions later
11/20/98... OEX +2.2% three sessions later (*)
04/21/98... OEX -1.6% three sessions later
09/19/97... OEX -0.4% three sessions later
07/03/97... OEX -0.9% three sessions later
05/02/97... OEX +0.4% three sessions later
01/22/97... OEX -2.9% three sessions later

Note that in the majority of cases this setup has meant limited upside
potential for stocks over the next few sessions. In only four cases out of
thirty-five, or 11% of the time, was the OEX up 1% or more three days later.
In the same period of time, the market's at-any-time odds of gaining 1% or
more over the next three sessions was nearly 30%.

A good setup to remember whenever the VXO closes in statistically oversold
territory is to note that day's low price on the OEX (that's the sell
trigger). If the OEX breaks below that price at any time within the next three
sessions, we can assume that volatility is rebounding to the upside and
causing a general market selloff. This is a short-term 1-2 day sell signal,
with the objective being a close below the trigger point either the same day
or the next. Over the past fifteen years, this setup has maintained an 80%+
accuracy level (see table below). For this setup to be triggered, the OEX
would need to trade below today's low of 620.19 anytime within the next three
sessions. Should that occur, odds would favor a settlement below that level in
short order...

VXO Under Lower Band, OEX Trades Below
Setup Day's Low Within Three Sessions
02/25/08 - ???
12/24/07 - Sell 12/27 @ 693.69 - lower close same day
09/21/07 - Sell 09/24 @ 710.47 - lower close same day
11/21/06 - Sell 11/24 @ 651.49 - lower close same day
08/21/06 - Sell 08/22 @ 598.91 - lower close next day
11/03/05 - Sell 11/04 @ 559.46 - no lower close
09/09/05 - Sell 09/13 @ 573.17 - lower close same day
06/21/05 - Sell 06/23 @ 570.37 - lower close same day
04/12/05 - Sell 04/14 @ 558.26 - lower close same day
02/02/05 - Sell 02/03 @ 567.93 - no lower close
12/23/04 - Sell 12/27 @ 574.72 - lower close same day
06/08/04 - Sell 06/09 @ 553.43 - lower close same day
05/16/03 - Sell 05/19 @ 473.48 - lower close same day
11/15/02 - Sell 11/19 @ 456.09 - no lower close
12/27/01 - Sell 12/31 @ 587.31 - lower close same day
11/19/01 - Sell 11/21 @ 588.98 - lower close same day
10/26/01 - Sell 10/29 @ 562.48 - lower close same day
06/05/01 - Sell 06/07 @ 654.05 - lower close next day
05/21/01 - Sell 05/23 @ 665.42 - no lower close
08/08/00 - Sell 08/10 @ 799.12 - lower close same day
11/19/99 - Sell 11/23 @ 746.27 - no lower close
10/08/99 - Sell 10/13 @ 684.63 - lower close same day
08/25/99 - Sell 08/27 @ 711.07 - lower close same day
06/07/99 - Sell 06/08 @ 671.44 - lower close same day
04/22/98 - Sell 04/23 @ 543.97 - lower close same day
09/22/97 - Sell 09/23 @ 458.30 - lower close next day
08/06/97 - Sell 08/08 @ 463.21 - lower close same day
07/03/97 - Sell 07/09 @ 440.58 - no lower close
01/22/97 - Sell 01/23 @ 381.75 - lower close same day
07/01/96 - Sell 07/03 @ 323.95 - lower close next day
08/08/95 - Sell 08/10 @ 264.62 - lower close same day
01/16/95 - Sell 01/19 @ 216.59 - lower close next day
06/16/94 - Sell 06/17 @ 212.54 - lower close same day
03/17/94 - Sell 03/18 @ 217.07 - lower close next day
06/28/93 - Sell 07/01 @ 207.64 - lower close same day
06/17/93 - Sell 06/18 @ 208.21 - lower close next day

Categories : Archived EOD Commentary, End-of-Day Commentary

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