- The VIX should be not interpreted on an absolute basis.
- The VIX should be interpreted on a relative basis.
- Here's how you can use the VIX to predict a pullback in Berkshire stock.
Let's be honest, even long-term "investors" try to time the market, even though they berate the short-term trader. These participants could learn a few things from their "short-sighted" brethren. So let's see how we can use the VIX to predict a pullback in Berkshire Hathaway (NYSE:BRK.A) stock. Larry Connors who is one of the best market timers says that the VIX needs to be interpreted as a dynamic indicator, not a static indicator. How many times have you heard guests on CNBC saying that the VIX should do X or Y because it is above or below a certain point? Well here is an article going back to early July of this year. I will focus in on a particular paragraph:
"It is worth noting that the VIX's moves are frequently tracked by absolute levels rather than by percentages. Since the VIX never rose substantially above its long-term average level of 20 even amid the Brexit market tumult, the VIX only fell about 11 points in the week. Yet, even that is the largest absolute one-week drop in the VIX since late 2008."
None of these professionals appear to understand the mean reverting nature of the markets. It is very unfortunate that poor knowledge is spread by a group of people who should know better. Larry Connors has a short term oriented strategy with the VIX. Now, don't tune out just because I used the words "short term." We need to be honest with ourselves. If we're talking about crashes and pullbacks, and asking if a stock is a "good buying opportunity" after dropping for a week, etc, then we really are being short-term oriented, while using the "long term" tag as a facade.
Here is how you are supposed to use the VIX. You apply the 10-day moving average. Why? I don't know the answer to that, but Larry Connors has done so much statistical testing, that there is no need to question the number. Simply, apply it. The idea is that there will be a certain percentage where the price of the VIX will move away from the average and "snap back." This is the mean reverting tendency. The absolute VIX numbers themselves are totally junk. Since most of you are concerned with falling markets, (I never understood this obsession.), take a look at this.
The alignment is slightly off, but the arrows should draw your attention to where the actual alignment occurs. What you can see is that the VIX will help to predict snapbacks in BRK.A stock when it exceeds a certain percentage of the moving average. According to Larry Connors, it is five percent. These tools are handy, and could potentially help you get a better price on your investment. Just because the VIX rises, it does not mean Berkshire stock will crash. It means that the further away it moves from its average, the harder the snapback.
Below are a few more examples. Again, pardon the alignment issues.
Here is a final example.
When the VIX starts rising in short bursts past the moving average, be ready for the mean reversion to occur. Don't see the market as ready to fall into the abyss. It is quite the opposite. Keep in mind, that this is just one way of understanding the twists and turns of the market. The idea is not to become afraid if the VIX spikes. The ability to interpret things correctly can help us avoid going into panic mode. If you also fancy tech stocks, take a look at Amigobulls' top tech stock picks, which have beaten the NASDAQ by nearly 120%.