Where’s the complacency gone?

A few days ago, I showed the VIX chart and suggested that we are at the start of a big wave 3 up and the next test was to be the 20 level.  Yesterday, it almost made 20.

The VIX is a measure of the fear (or lack) in the market as it measures option premiums for S&P puts and calls.  When premiums narrow for puts (betting on a price fall), complacency has settled on the market.  Traders believe there is little downside risk. And when premiums for puts widen, the fear of declines is increasing.  That is why the VIX is called the Fear Index.

Now the S&P has declined steadily off the 19 September high, the fear level has jumped – and the  ‘will they, won’t they’ drama over the US debt ceiling deadline and shutdown has arrived on the scene just in time to ramp it up even further.

But the S&P has declined to the Fibonacci 62% retrace – and the chart support high of 25 August.

The odds favour a bounce from here although many pundits have been forecasting a post-Congress agreement rally (see seekingalpha.com for numerous predictions), which makes any bounce less potent.  This assumes an agreement will be reached, of course.

The smart money will be looking to sell into any rally.  Meanwhile, watch the VIX as it has the potential to stretch well above the 20 level in the next few weeks.