Two Simple Tools to Spot Reversals in the Fear Gauge

2018 and 2019 will go down in history as one of the most volatile periods on record. Coronavirus fears sent volatility through the roof in 2020.

But believe it or not, one of the most consistent ways to make money on the market is by trading excessive fear, as dictated by the Volatility Index.

All we need to watch are agreements between Bollinger Bands (2,20) and Williams’ %R.

Bollinger Bands (2,20)

Remember, Bollinger Bands let us know how far we can pull our rubber band before it snaps back and reverts to mean. If we look at the VIX over the last two years for example, we can clearly see that once the upper Band is touched or penetrated, the VIX pulls back.

In February 2018, the VIX exploded to 50 but could not sustain that level outside the upper Bollinger Band.  Not long after it pulled back. We saw the same thing happen at other VIX extremes in March 2018, June 2018, July 2018, October 2018 and in November 2018.

While it’d be nice to just use one technical indicator to tell us when to buy or sell, we know that’s never a safe gamble. So, we want to confirm our findings with another key indicator.

Williams’ %R (W%R)

When Williams moves to or above its -80, it’s an indication the asset is oversold. When it moves to or above the -20-line, it’s overbought. 

Notice what happens when the upper Bollinger Band is hit or penetrated, as Williams’ %R pushed to or above its 20-line. It’s an indication of excessive fear, and a strong likelihood of a near-term reversal. In fact, about 80% of the time when the two confirm one another, we see a reversal in volatility and upside in the broader markets.

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The question then becomes –how can we trade reversals in volatility?

There are two key ways.

One is the ‚ÄčProShares Short VIX Short-Term Futures (SVXY). The other is the VelocityShares Daily Inverse VIX ETN (ZIV).

As volatility begins to reverse, these two opportunities typically turn higher.

It’s just another strategy to be well aware of when looking to take advantage of outrageous spikes in volatility.