The Fear Gauge: History is Repeating Itself Again

It was an occurrence so rare, we hadn’t seen it in 24 years, we noted mid-May 2017.

The infamous fear gauge – the VIX – had fallen to an unusual low of less than 10 – something we hadn’t seen since December 1993. No one thought anything of it. Markets continued to run higher. And no one, it seems, was paying attention. But we were. 

That’s because historically, each time the VIX fell under 10, markets fell not long after. 

As we also noted mid-May 2017, after reaching a low of 9.31 in 1994, the Dow Jones Industrials slipped from a high of 4,000 to less than 3,550.  After reaching a low of 9.64 in December 2006, the Dow Jones fell from 11,013 to 10,661.  Each was a rarity. But when it happens, we need to be cautious in how and what we trade. 

By the time the VIX hit a low of 9.56 on May 9, 2017, we knew it was only a matter of time before history repeated itself. And then it happened. 

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Fear exploded.  The VIX popped to a high of 15.71. The Dow Jones Industrials plummeted 370 points within hours. Panic resumed. Any one that positioned for a potential sell-off with the VIX at sub-10 did well. Others panicked.  Stop losses were taken out. Sellers ran for the exits. Chaos ensued.

Many weren’t prepared. Others thought this was the beginning of the end.

But it was at that point when you want to buy the blood in the streets, as Baron Rothschild noted. You want to get greedy as others get fearful, as noted by Buffett. You want to buy the excessive pessimism, as Sir John Templeton did.

Those that did stood to make a fortune from others’ demise. 

In fact, look at what the herd was telling us technically. 

The VIX was now outside of the upper Bollinger Band, over-extended as fear reached epic highs. Williams’ %R was well above 20. MACD had spiked. RSI was at its 70-line. All confirmed that fear had in fact run its course.

Any one that rushed to buy the chaos watched as the Dow Jones Industrials recovered about 400 points, as the VIX topped out. All they had to do was buy the fear highlighted by the VIX and buy stocks when the VIX got too high.

It’s a contrarian’s dream come true.

In late May 2017, there was reason to be fearful again, though.  Even with excessive bullishness and analyst crowing about another 50% of market upside, the VIX was sitting at less than 10.  The Dow Jones was sitting at triple-top resistance levels, as RSI and Williams’ became overbought, as well.

Folks buying at such a lofty high stood to get burned again, as the VIX warned.

It’s something to be well aware of as you trade.

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