By Jeff Clark – the editor of the Delta Report Newsletter
Here’s the chart I’m paying the most attention to this week…
This 60-minute chart of the CBOE Volatility Index (VIX) displays a “bearish falling wedge” pattern with positive divergence on the MACD indicator. This is a potential bottoming pattern that forms as a chart makes lower highs and lower lows, and the distance between the highs and lows gets smaller.
This action brings the support and resistance lines together and creates a wedge. As the chart approaches the apex of the wedge, traders should look for a large move in one direction or the other.
So, we’re getting close to a breakout of this pattern.
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The positive divergence on the MACD momentum indicator suggests that the breakout will be to the upside. And since this is a 60-minute chart, the pattern should play out within the next few days.
If this chart does break to the upside, then the pattern projects a move up to somewhere between 22 and 26. That’s not a huge move. It simply gets the VIX back to where it was at several days ago. That should be enough to induce a modest pullback in the broad stock market.
That would be healthy. It would relieve some of the short-term overbought conditions, form a higher low on the daily chart of the S&P 500, and set the stage for another rally phase as we head into the end of the month.
If, on the other hand, the VIX breaks to the downside, then we have a more serious concern.
Here’s the daily chart of the Volatility Index along with its Bollinger Bands…
At the moment, the VIX is trading about 15% above its upper Bollinger Band. But, if the pattern on the 60-minute chart breaks to the downside, the VIX will most likely close below its lower Bollinger Band. That sets the stage for a broad stock market sell signal once the VIX closes back inside the bands.
The red circles on the daily chart show the previous times over the past year we’ve seen a VIX sell signal. Each time led to an immediate decline in the stock market. Some declines were mild, like in early August when the S&P fell a mere 40 points before the VIX then generated a buy signal.
Other declines were far more severe, like the drop following the November sell signal – when the S&P lost nearly 200 points.
One way or another, the VIX is likely to trigger a decline in the market this week. The difference is if the 60-minute chart breaks to the upside, then any decline should be brief and shallow and lead to another rally attempt later this month.
If the 60-minute chart breaks lower, then we may get a quick pop higher in the stock market. But, that pop will likely be followed by a more significant and severe decline heading into the end of the month.