This indicator is a measure of volatility. It’s not like the VIX or any other indicator that simply gives you an indirect idea of the market sentiment. This indicator actually determines how volatile the markets will be. Higher readings are associated with higher volatility and vice versa. We have also determined levels, which correspond to extreme volatility, once these levels are broached, which is the case since Dec 2013; one can expect extreme swings in both directions.
This indicator works well in conjunction with the Trend indicator. Higher readings usually mean that the largest part of the move will be seen in the direction of the trend. As of 2012, the trend has been generally bullish and as such the largest moves have occurred towards the upside.
Extreme readings widen an index or stock’s trading range before they hit the extremely oversold or overbought ranges. For example, normally a stock trading from $10 to $20 in 6-9 months might be considered overbought, and if it trades to the 25-30 ranges extremely overbought. Now with volatility readings well past the extreme zone, say in the 3000-3300 ranges, 25-30 might actually turn out to be overbought, and a move of over 45 to fall into the extremely overbought ranges.
This is just an example to give you a visual outlook of how this indicator works. Ultra-high volatility readings change the outlook; what was extremely overbought could now be construed as just slightly overbought and vice versa? This is all tied in with the greed factor; the need to get the most one can in the shortest possible time period with as little work as possible.
volatility indicator also measures actions outside the market
It is also our opinion that higher readings indicate that the level of market manipulation is increasing. Higher readings correspond to higher levels of market manipulation. Once again, this would explain the Dow’s incredible feat of not experiencing a single significant correction after 2011.
This phenomenon was 1st revealed last year. In Oct 2008, the Dow bottomed, and then it went to put in the classic head fake where it put in a lower low in Nov 2008. In between Oct and Nov 2008, the markets experienced several selling climaxes; VIX soared into record territory, put-call ratios spiked, the number of individuals bearish on the market set new records, we had multiple positive divergence signals, several daily buy signals, etc., In essence, everything was in place for a turnaround.
The only anomaly was that volatility readings remained at extremely elevated levels; this meant that the zones determining where extremely oversold began would be widened significantly. The Dow rallied briefly and then took out its November lows. It moved from the oversold to the very oversold, to the extremely oversold and then finally into the extreme of extremes and just to add a bit more pain it dipped a tad bit more before putting in a bottom at 6469. It dropped almost 1000 points below its Nov 2008 lows. The same thing appears to be occurring now but in the opposite direction.
To summarize the functions of the volatility indicator
- Higher V readings mean that the markets will experience wider volatile swings, but the bulk of the moves will occur in the direction predicted by the Trend Indicator.
- Higher V readings will widen the trading ranges. The market will have to move higher to enter the overbought ranges and even more to trade into the extremely overbought ranges and vice versa.
- This indicator works very well with the Trend Indicator.
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