"Stocks Experience Largest Four-Day Decline In Two Months." Or how about "S&P500 On Track For Worst Week Since Mid May?" Less mesmerizing those same "direct from CNBC" Breaking News headlines amounted to profit-taking of about 4.15%. In the scheme of things and following a fifty-plus percent run over six months and change, that's not a whole lot to cry over. Well, you'd think or at least I would.

Our market cheerleaders could have livened up the market's defiant behavior, if you're willing to overlook losses of 23% for the past month in Shanghai, by rightfully noting our stateside death throes really occurred over two days and not the four determined by bean counters using new math methods.

So, here we sit at "SP-1000" (SPY) once more. As traders might remember, the coveted psychological support was the source of many recent celebrated jumps and jeered dumps on numerous occasions as the index was volleyed back-and-forth across the closely-watched level. Looking only at the daily chart and Tuesday's action marks the ninth out of twenty-two sessions or nearly half of the day's since August, where "1000" came into play.

What will happen this time around? Nobody but Mr. Market, umm Goldman (GS) knows for certain. However, the CBOE Volatility Index or "VIX" ($VIX) has been bracing for stormy weather for quite some time now, despite the SPY reaching intermediate highs this past Friday. For contrarians, that's ultimately a good sign. It means "buying the dip" as part of a well-conceived plan, could be happening sooner, rather than later. However, traders may want to make sure they properly qualify and quantify seeing the whites of the other guy's eyes before pulling the trigger.

There are lots of new measures and instruments related to market volatility, but the cash VIX remains the elder statesman and the only related gauge of investor fear and loathing that I dare attempt to gauge the pulse of the market with. How about the listed options on the VIX? No thanks. It's too convoluted and complex for my simple ways.

First and foremost for me, a short-term gauge of extreme investor behavior is found by measuring the percentage distance i.e. VIX Stretch, of the cash relative to its 10-day simple moving average. For market downturns or corrections, readings greater than 15% generally creep into the picture as the price action is reaching its conclusion and a bullish market reversal is in the works.

At the end of Tuesday's session, the VIX closed at 29.15% and its 10-day stood at 26.10%. The near three point difference equates to a percent difference of 11.50%. That falls short of a minimum 15% guideline I've been weaned on and learned to appreciate. Are rules meant to be broken? My answer is that much more often than not, "No."


Figure 1: CBOE VIX ($VIX) Weekly Chart

Traders may rely on other charting factors such as a candlestick reversal on the VIX, the feared "30% VIX!!" or one or two month highs in order to override or fade a "close" VIX Stretch situation. Personally though, even when those factors do come into play, I'd use the "good enough" government standard of bean counting sparingly when it comes to front-running or undercutting the signal with those secondary confirmations.

Readings such as the VIX's once feared 30% level have obviously lost a bit (but far from all) of their importance over the past year as history-making highs nearing 90% were scored. On the other hand, the mean-reverting tendencies of the index and its always-on-the move, moving average-by their very nature, are much more likely to remain robust. In fact, during last fall's malaise, the 10-day moving average acted as the closest thing to technical support in buying momentum on pullbacks.

Back to a more normal market situation where we use the 10-day for stretched conditions, the last such buy signal for the broader market was on July 8. At the same time while headlines and charts centered on Head & Shoulder breakdowns and targets of SP-800 and beyond-the VIX Stretch pushed nearly 18% before topping out in its own bearish gravestone doji. At the same time, the SPY was down a near perfective and corrective 9.50%. Now those are rules made to order.

Entering Wednesday and bearing in mind a "Shanghai'ed" 23% correction and bulls just entering that most treacherous of months after a historic rally-an 11.50% VIX Stretch and "SP-1000" doesn't quite cut it for this market strategist. If anything, I wouldn't be betting the bank without those fore-mentioned secondary confirmations when, not if, we see investor panic in excess of 15%.

Chris Tyler
Senior Staff Writer & Options Strategist
Optionetics.com ~ Your Options Education Site
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The information offered here is based upon Christopher Tyler's observations and strictly intended for educational purposes only, the use of which is the responsibility of the individual.