Why Stock Market Investors Need to Fasten Their Seatbelts

August 20, 2020

“Because financial markets are a fractal, present conditions never maintain”

By Elliott Wave International

Elliott Wave International’s analysts have long noted that periods of low stock market volatility are almost always followed by periods of high volatility.

Granted, periods of low volatility can stretch for a while, yet a change occurs sooner or later — and that shift is often dramatic.

Here’s a case in point from the Elliott Wave Theorist which published on Oct. 23, 2017 (The Elliott Wave Theorist is a monthly publication which offers analysis of financial markets and social trends):

Persistent new highs in stock prices week after week and recently day after day have led to a substantial reduction in the volatility of stock prices, to the point that the CBOE Volatility Index has just reached an all-time low.

The VIX futures contract is widely characterized as a bet on the future, that is, as a gauge of expected volatility. But futures contracts always reflect the present, never the future. And because financial markets are a fractal, present conditions never maintain.

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As you may know, a fractal is an object that is similarly shaped at different scales.

At the time the chart published, Large Speculators were short a record number of VIX futures contracts.

Yet, it wasn’t long before the inevitable changed unfolded.

Stock market volatility took a big jump in late January and early February of 2018, with the DJIA surrendering 10% in less than two weeks.

And 2018 also brought other periods of eyebrow raising volatility.

On Dec. 7, 2018, Bloomberg reported that the S&P 500 had 1% daily trading swings 56 times up to that point in 2018.

What does that have to do with the present?

Well, the August 14 U.S. Short Term Update, an Elliott Wave International thrice-weekly publication which provides near-term forecasts for major U.S. financial markets, notes:

With the exception of five days in early June, the VIX has been declining since March 18, when prices spiked to a high at 85.47. This five-month decline culminated with a streak of 7 consecutive lower closes through August 10. … Currently, Large Speculators are net short nearly a third of all open interest in VIX futures.

Of course, it’s possible that the VIX slips to even lower lows before a jump in volatility unfolds.

One invaluable analytical tool to use along side the VIX is the Elliott wave model, which is fully described in the Wall Street classic book, Elliott Wave Principle: Key to Market Behavior, by Frost & Prechter. Here’s a quote:

No matter what your convictions, it pays never to take your eyes off what is happening in the wave structure in real time. Ultimately, the market is the message, and a change in behavior can dictate a change in outlook. All one really needs to know at the time is whether to be long, short or out, a decision that can sometimes be made with a swift glance at a chart and other times only after painstaking work.

Get more insights into the Elliott wave model by reading the entirety of the online version of Elliott Wave Principle: Key to Market Behavior.

Simply become a member of Club EWI, the world’s largest Elliott wave educational community, and access to the book is 100% free. Club membership is also free.

Follow this link: Elliott Wave Principle: Key to Market Behavior.

This article was syndicated by Elliott Wave International and was originally published under the headline Why Stock Market Investors Need to Fasten Their Seatbelts. EWI is the world’s largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.