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Pennant in VIX, S&P 500, or Both?

Just had a friend drop me a note questioning whether the VIX was forming a massive pennant.  If you are not familiar with the technical analysis jargon, a pennant formation is represented by a quick move up followed by lower highs and higher lows.  Generally as you move through the pennant you expect to see volume decrease:

Bullish Pennant formation for a stock price

If you look at the VIX, it definitely matches the description:

 

VIX Pennant Looks Ripe to Breakout to the Upside

This same pattern can also represent a bearish case when forming an upside down pattern as so:

 

A Bearish Pennant Formation for a Stock

It just so happens that the S&P 500 is not only showing a bearish pennant formation, but a steadily decreasing level of volume…

 

Bearish Pennant forming in the S&P 500?

You might think that these are all witch doctor type signals, but the fact is that many traders watch for these patterns.  When enough people believe in them, they can often become self fulfilling. To the true technicians – I apologize if the the lines are not drawn perfectly….the point is only that there is a certain amount of consolidation occurring in both indexes.

On a back to reality note, this Jackson Hole meeting on Friday could be the catalyst for even more extreme volatility.  Mr. Bernanke has trapped himself in a box.

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7 Responses

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  1. Hugh Jazz says

    Forgive my total lack of technical analysis expertise… but does TA even work on the .VIX index? I believe that index isn’t like others, because instead of being based on real money transactions on the asset itself, the .VIX is a calculation that goes off of the implied volatility in derivative instruments (calls and puts) on the S&P 500.

    Also, I’ve seen other folks who (unlike me) are experienced doing TA that it just doesn’t work for something like the .VIX.

    Please set me straight if I’ve been reading the wrong stuff. I’m just not sure what is correct. Thanks very much.

  2. SurlyTrader says

    The VIX is a mean reverting index, therefore a pennant *should not* work as well on the VIX. We would expect gravity to pull the VIX down, whereas many stocks have a natural bias upward. That said, the formation is just a sign of consolidation…there is a strong move in one direction, the trend loses steam but cannot decide on a direction and then some event or news item forces it to break out of the pennant with speed. I doubt this will happen with the VIX, so I would lean to side with you. Also, even if the S&P breaks out to a lower level…that does not mean that the VIX will move higher. The VIX tends to peak much sooner than the underlying bottoms out.

  3. Hugh Jazz says

    Thanks for responding. That’s a good point about mean reversion in the .VIX.

    But here’s where I still had doubts about using TA on the .VIX, mean reversion aside: I thought technical analysis’ predictive power comes from the fact that market participants are voting with real dollars constantly. (The real money being key, because you know they care very much about the return on their capital… clearly that gives us a more accurate barometer than folks trading in “pretend” portfolios, or answering questions for some survey.) Their money is at stake, whether you’re looking at a chart for AAPL, or the S&P 500.

    However, the .ViX is different (I’m pretty sure), because you can’t really buy it or sell it short. I think of it as a kind of a statistical byproduct of transactions in derivative instruments, with the underlying being the S&P. I guess that is why I figured it wouldn’t be a proper candidate for TA. It doesn’t have actual price or volume data.

    Again, I apologize for my ignorance, and I do plan to study up on TA. Just wanted to see in the meantime if I am totally off-base? Thanks for your patience.

  4. SurlyTrader says

    You can indirectly trade the vix by purchasing or selling 1 month puts and calls and delta hedging that position. Institutions and hedge funds do get close to “trading the vix”. Retail investors can indirectly trade the VIX by buying and selling VXX or VIX futures. The actual options are more closely related, the futures are less closely related.
    I had previously written about trading the gap between the two:
    http://www.surlytrader.com/vix-versus-vix-futures/

    So real money is in the VIX index through the options market activity and VIX futures market.

  5. Hugh Jazz says

    OK, thanks!

  6. Chance says

    I’ve been watching these patterns develop too… I think TLT is putting in some kind of continuation pattern as well, signaling more downside in the stock market.

    All bets are off though with Jackson hole tomorrow. Bernanke seems obsessed with not letting any kind of meaningful bearish trend develop on the charts. Too bad… If the markets would just be allowed to do what they want without constant interference from the government, we might finally have a real ‘recovery’.

  7. M Wei says

    Yep, I saw that too. See my blogpost at: trendmester.blogspot.com

    The way to plot a more normal looking graph from VIX is to take the inverse of it, like 100/VIX. I think the pennant may look better that way.



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