Sentiment Surveys and the VIX

Click on Chart to Enlarge

In recent posts, I have noted how put/call ratios, the VIX and VXV, and blogger opinions are getting to ranges that have had bearish implications in the past when looking ahead a couple months.

One piece of the sentiment puzzle that I have not mentioned here in a while is related to investor sentiment surveys, which can be extremely useful contrary indicators. There are several classic surveys followed by investors, but if I had to pick a favorite it would probably be the American Association of Individual Investors (AAII) survey. This survey tends to fluctuate quickly enough to make it very useful for intermediate term trading.

I find this survey to be most useful as a contrarian indicator used to trade in the direction of the 200 day moving average. Since the 200 day moving average is pointing lower now, this basically means that I would use a statistically high bullish % in the survey to initiate bearish trades. Since October the bullish opinion has been rising but us still not even 1.5 standard deviations away from the 1 year average. However another 1-2 weeks of rising prices and a break above the 920 level of the S&P 500 would likely raise this bullish % to statistically meaningful levels in my opinion. Most other surveys are still very neutral or are near pessimistic extremes, so I feel that there may not be enough of a sentiment shift back to the optimistic side to push the market lower just yet.

Another thing I watch closely for timing major market moves is the VIX. I look at the VIX in several different ways from oscillators to trendlines to bollinger bands to retracement % to Elliot Wave patterns and even a rather unique (I think) running tally of higher highs or higher lows since a significant market top or bottom.

Since the November market lows the VIX has made 8 lower lows. Anything beyond 12 and flags go up for a potential reversal. Based off this system, I think the VIX could drop a bit more and the market could rise more before we get into the danger zone.

Also I have noticed an almost uncanny tendency since the 2006 VIX lows for the VIX to retrace 78.6% (roughly 80%) of any major VIX advance. The chart at the top of the page shows the VIX with several retracements of this nature. A 78.6% retracement of the VIX advance from August 2008 lows to October 2008 highs would place the VIX at roughly 35. This happens to be the VIX level that repeatedly capped VIX advances in 2007 and early 2008. So we could have a case where old resistance becomes new support.

Peace, Love, and Merry Christmas to all!

Pete