December 18th, 2010

Debunking VIX Predictive Value

Before we all get involved away from the market, I want to wish all a Merry Christmas and a Happy New Year .

I also want to thank you for being here with me. I can’t believe it but am proud to say this is the 600th post of “Stock Chartist”. All of them can be found in the archives (I accidentally deleted some of these earlier posts so I don’t have a true count of total postings but I’m guessing it closer to 700). I started the blog in 2005 and hope to be celebrating its Sixth Anniversary on July 1.

Friends ask why I continue this labor of love for anyone who’s interested (or the small fee for those who want a more personal form of interaction by subscribing to Instant Alerts). To them I answer that it’s been fun, I earn psychic rewards when I turn out to be more correct than the well-paid “talking heads” and Wall Street pro’s and by helping you readers by offering a unique point of view and, hopefully, perhaps even some financial benefits.


Someone asked whether we should be concerned because the VIX is below 20 and appears to be making a head-and-shoulder pattern indicating that it probably will be heading lower (click on image to enlarge):

I’ve written before about what I believe is the lack of predictive information in the VIX (“Does VIX Inform or Mislead?” on October 1, 2008 and “Ignore The VIX As A Market Trend Indicator” on March 17, 2010) but the question continues to come up. How low could the VIX go and would it be ominous for the market even if it did decline? The “talking heads” always tell us that a VIX below 20 is a sign of complacency and a sure indication that the market is vulnerable to a correction or major fall. Some say that’s been the pattern ever since the Tech Bubble. A year ago, for example, CNBC posted an article entitled “Is the Low VIX a Warning for Stocks?” and repeated the old Wall Street saying: “VIX low. Time to go.”

But lets see what the statistics actually say. The S&P was 1225.35 on June 22, 2001, nearly 10 years ago but almost exactly the same level as last Friday’s close of 1243.91 (that tells you something but that’s the topic of another post). I wanted to see how predictive the VIX actually was over those ten years. I compared the VIX on each of those 2,387 trading days against the change in the S&P 500 Index over the following 30, 60, 90 and 180 days. I plotted the results on an XY-graph and came up with this amazing picture when all the possible combinations of 9165 trading days were overlaid (click on image to enlarge):

If you’re not interested in seeing the chart close-up I’ll tell you what it says:

  • The VIX has been below 20 nearly as many times as it was above; when VIX was below 20, the market has risen 53% of the time, regardless whether over 30, 60, 90 or 180 days.
  • The VIX has been above 20 52.6% of the time and the market declined 61.7% of the time whether over 30, 60, 90 or 180 days.

I conclude, once again, the VIX has no longer-term predictive value. For individual graphs of the different time periods click here:

Subscribe below or click here to learn more about help for navigating turbulent markets.
  • Ben

    This is fascinating. I was recently thinking about this question and you answered it. Are there any conclusions you can make about it other than it bears no significance?

  • Joe

    It could be important for day-traders and those promoting options trading on the VIX (like the Najarians).

  • Ben

    In my model for SPY the ATR (Average Trading Range) functions as a measure of volatility. In recent history, when the ATR drops to about 1.0% or lower of the stock price, as it has since December 14th, the market corrects. Note that from March 31st to April 27th of this year, the ATR was stablile at 1% or .9% each day. Suddenly on April 27th on 2X heavy volume the market dropped. Within 1 week was the flash crash. By June 9th SPY's had dropped from 121 to 106. This was when Greece hit. Could another nation surrounded by water be the cause of the next one?