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Should We Apply Technical Analysis to VIX and Volatility?

Should We Apply Technical Analysis to VIX and Volatility?

Talking Points:

  • Technical analysis does not work particular well on measures of activity or features of a system like it does for market pricing
  • However, with the securitization of VIX and volatility measures; this segment may be more critical in generating financial system movement than indexes
  • There are large wedges closing on their apexes near record lows for both the medium-term VIX and short-term VXST that deserve attention

What are the DailyFX analysts' fundamental and technical forecasts for the Dollar, Euro, equity indexes and more through the fourth and final quarter of the year? Download the recently-released 4Q forecasts on DailyFX.

Normally, I don't apply technical analysis to data and derivative measures of the financial markets. I am a believer that most technical analysis - with the exception of some momentum and similar readings - is a degree of self-fulfilling prophecy. When there is a psychological level, an extreme oscillator reading or familiar chart pattern; the mere recognition from a wide enough swath of the market in a particular market backdrop (more speculative influence than 'investor') promotes a response from market participants. That shouldn't be the case with something like GDP readings or from volatility measures. The increasingly popular VIX Volatility Index - dubbed the 'fear' gauge - is a measure of implied volatility a month forward derived from S&P 500 options. This is in essence measure of anticipated activity over that period or often considered a cost of insurance. Yet, that rudimentary role is definitely changing.

In the past years, we have seen a dramatic rise in popularity surrounding activity measures - probably because they exploded during the Great Financial Crisis and then completely collapsed in the years that followed. At this point, with no actual volatility to seemingly be found in the spot capital markets, it seems volatility itself becomes more interesting. With an interest and an ambitious financial sector, it should come as little surprise that an effort to securitize this market measure has led to extremely popular products with sometimes dubious backdrop and suitability as investments for the average market participant. On the one hand, we have the VXX short-term volatility ETN which has seen an explosion of volume over the years despite projecting a constant devaluation - far more aggressive and not-zero bound than the indexed VXST. Then there is the XIV inverse volatility measure which has become the 'buy the dip' outlet for those seeking atypical vehicles for the popular call.

With a surge in interest in volatility and the outlet to actual express market views through these products, we find the speculative market splitting its view and funds. Where markets like equities, commodities and exchange rates are struggling for income and healthy price swings; it should come as no surprise that the volatility assets draw greater interest. However, as the focus shifts to these derivative markets, we find that evaluations on the broader financial system are made increasingly on the moves that the derivatives make rather than the underlying. In other words, we find a 'tail wagging the dog' situation. And so, the technical patterns that we find on measures like the VIX or VXST present a different potential. No longer are they simply open to the whiles of what the S&P 500 does, but trading pressure behind the related products can actually charge the volatility measure itself and leverage the very activity in the capital market. We discuss the changes in activity measures and the opportunity it presents for applying technical analysis on new charts in today's Quick Take Video.

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.