The days of low volatility seem to be over based on the chart of the iPath S&P 500 Short-Term Futures ETN (VXX), which we discuss below. Based on the construct of the volatility index, many active traders are starting to question the conviction of the uptrend and are beginning to analyze broad market indexes and exchange-traded funds (ETFs) to get a sense of whether there are any signs of a major reversal. In this article, we take a look at a few of the charts and try to determine what could be in store for the markets over the coming weeks. (For more, see: VIX Hits 5-Month High as Bonds, Stocks Wobble.)
iPath S&P 500 VIX Short-Term Futures ETN (VXX)
The volatility index, also referred to as the fear index, is commonly used by investors and traders alike to gauge the stock market's expectation of volatility as implied by a composition of index options. In recent years, with the rise in popularity of exchange-traded products such as the iPath S&P 500 VIX Short-Term Futures ETN, it is now possible to gain exposure to volatility as an asset class.
Taking a look at the chart below, you can see that volatility has trended lower for years, but the sudden spike earlier this year has changed the game. The price has been able to close above long-term support for the first time in a couple of years, and the sharp rise looks as though it will lead to a golden crossover between the 50-day and 200-day moving averages. Having the 50-day moving average cross above the 200-day is a common long-term buy signal and is often use to mark the beginning of major shifts in trend. (See also: How to Profit From Market Volatility Using ETFs.)
When the value of the VXX ETF rises, it is inherently due to an increased interest and purchase of S&P 500 index put options. As more investors start to hedge their exposure to the market and start to worry about a pullback, it is natural for selling pressure to build. As the fear, uncertainty and downside momentum build, it becomes a race for the exits, and prices start to drop.
Taking a look at the chart of the SPDR S&P 500 ETF (SPY), you can see that the price has recently closed below a key ascending trendline. This technical sell signal could be the catalyst that active traders have been waiting for to trigger the placement of their sell orders. The bearish close as shown by the red circle suggests that the sellers are in control of the momentum, and traders will likely maintain a bearish outlook until clear buy signals start to counter the decline.
Despite the negative news surrounding tech stocks such as Facebook, Inc. (FB), the tech-heavy Nasdaq has managed to stay above its ascending trendline, as shown on the chart of the PowerShares QQQ ETF. Since the tech sector has managed to lead much of the uptrend, this is a sector that active traders will be paying particular attention to. A close below the dotted trendline could be the final straw that signals a broader market sell-off. The next few trading sessions could prove to be critical as to the direction of the trend over the coming months. (For further reading, see: 3 Ways to Trade the Rising Volatility.)
The Bottom Line
Rising volatility is forcing many investors and traders to hedge long positions that they have accumulated over the past couple of years. The close above the 200-day moving average by the VXX ETF suggests that rising levels of volatility will likely be the norm. Active traders will likely continue to keep a close watch of the trendlines on broad market funds such as SPY and QQQ because several more closes below will likely trigger a flood of sell orders. (For additional reading, check out: 3 ETFs for Trading the Spike In Volatility)
Charts courtesy of StockCharts.com. At the time of writing, Casey Murphy did not own any of the assets mentioned.