What a remarkable week it was for the stock market. The S&P 500 gained 7.3% in just five trading days. Technical conditions went from oversold to overbought. Investor sentiment went from pessimistic to nearly euphoric.
And, from a contrarian perspective, my natural inclination is to view this recent rally as an opportunity to add some short exposure and bet on the market moving lower.
But, it’s too early to do that. There’s more upside ahead…
The Volatility Index (VIX) triggered a buy signal on October 30, when the index closed back inside its Bollinger Bands (BB). And, even though the market has moved sharply higher, and the VIX has moved lower, there’s still plenty of room for that trend to continue.
Remember – VIX buy signals in the month of October tend to lead to strong, multi-week rallies. And, we’re just one week into this one.
Look at this updated VIX chart…
Following the two previous VIX buy signals over the past several months, the VIX continued falling all the way to its lower BB. We can expect the same thing to happen this time.
As you can see from the chart, the VIX closed Friday about 15% above its lower BB. So, there’s still room for volatility to fall. And, falling volatility tends to go along with a rising stock market.
Now, look at this chart of the S&P 500…
As the index approaches its all-time high, none of the momentum indicators at the bottom of the chart have stretched into “extremely” overbought territory yet. There’s room for them to press higher.
Ultimately, this setup looks like it has the potential to create negative divergence on the indicators – which should eventually lead to a strong decline in the market. But, we’re at least several days, and maybe several weeks, away from that happening.
For now, the trend is bullish, and it looks like it’s going to stay that way a while longer.
Best regards and good trading,
Editor, Market Minute