Fear curve inversion
Updated
We are all familiar when a bear market starts. The fear instantly hits us, the cold sweat.
We've all been there...
To study bear markets and crashes, we need to study human psychology. Curiously, it is very predictable.
This is your mind, my mind, everyone's mind. Either you go through depression, either through financial disaster, it is the same.
I tried analyzing psychology before in this idea down below, I really enjoyed it.
As a trader, you might use two moving averages, for example one 50 day and one 200 day. To make sense of where you are, you need two measures. VIX is a measure of what we think future volatility will look like. So to make sense of it, you need something to compare it to. Answer? Current volatility.
TradingView offers a neat little tool called "Historical Volatility". So we have a way to estimate current SPX volatility and compare it to what everyone thinks volatility will be like in the next 30 days (VIX).
So I devised this chart, on top we see SPX. On bottom white we have a moving average of VIX index. On bottom orange we have the current volatility as measured by the indicator.
Let's head to a period of a "bear market". A period when relative calm exists and noone expects a crash.
During this period, we see that whenever there is a drop followed by a bear rally, the future expected volatility (VIX) decreases. Actual volatility (orange line) increases. It shows that everyone expects LESS volatility in the future ahead. Since a significant part of investors were convinced the bottom was in. The same we witness now. This is a vicious circle, something fundamental has to change in psychology to change the outcome. Either we find the button to fix all our problems, or we face the consequences that are fated to come upon us.
Down below I add some screenshots showing the periods where orange was above white. This is a period when we are hopeful of the future ahead of us, after we pass some trouble that came. If you need more info, do read the linked idea called "VIX | The effect on SPX"
PS. Just like yield curve inversions, there is room for error. A fear curve inversion means that you just have to stay alert.
Tread lightly, for this is hallowed ground.
-Father Grigori
We've all been there...
To study bear markets and crashes, we need to study human psychology. Curiously, it is very predictable.
This is your mind, my mind, everyone's mind. Either you go through depression, either through financial disaster, it is the same.
I tried analyzing psychology before in this idea down below, I really enjoyed it.
As a trader, you might use two moving averages, for example one 50 day and one 200 day. To make sense of where you are, you need two measures. VIX is a measure of what we think future volatility will look like. So to make sense of it, you need something to compare it to. Answer? Current volatility.
TradingView offers a neat little tool called "Historical Volatility". So we have a way to estimate current SPX volatility and compare it to what everyone thinks volatility will be like in the next 30 days (VIX).
So I devised this chart, on top we see SPX. On bottom white we have a moving average of VIX index. On bottom orange we have the current volatility as measured by the indicator.
Let's head to a period of a "bear market". A period when relative calm exists and noone expects a crash.
During this period, we see that whenever there is a drop followed by a bear rally, the future expected volatility (VIX) decreases. Actual volatility (orange line) increases. It shows that everyone expects LESS volatility in the future ahead. Since a significant part of investors were convinced the bottom was in. The same we witness now. This is a vicious circle, something fundamental has to change in psychology to change the outcome. Either we find the button to fix all our problems, or we face the consequences that are fated to come upon us.
Down below I add some screenshots showing the periods where orange was above white. This is a period when we are hopeful of the future ahead of us, after we pass some trouble that came. If you need more info, do read the linked idea called "VIX | The effect on SPX"
PS. Just like yield curve inversions, there is room for error. A fear curve inversion means that you just have to stay alert.
Tread lightly, for this is hallowed ground.
-Father Grigori
Note
Blue line above: SPXOrange line below: VIX
Blue line below: Historical Volatility indicator for SPX
White line: Line of Death?
PS. White line is drawn on the border of blue line. Don't blindly trust the official VIX index (future volatility). Make sure to compare it with the actual current volatility.
Note
NDQ just missed a significant trendline.Drawn with the magnet tool from the bottom of July 2010 to the bottom of December 2018. The 2020 black swan is ignored as an outlier.
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