Wall Street's so-called fear gauge spiked to the highest level since May as trade worries caused a sell-off in the stock market. That's likely a good thing.
The Cboe Market Volatility Index, or VIX for short, closed at 21.66 Friday. That was the highest close since May 23, when it closed at 22.29. The index is a measure of expected volatility based on S&P 500 option prices. The higher it is, the more cautious investors are trading.
But in a contrarian way, spikes in investor fear usually signal a bottom in the stock market rather than further weakness. IBD research found that when the VIX rises more than 20% above its 10-day moving average, it often signals a positive reversal in the market.
The signal has occurred several times this year, including April 7, May 23, June 13, Aug. 1 and Sept. 2. Each time, the S&P 500 made a low or was near a low. Of course, false signals do happen from time to time. The market continued to drop after a VIX bottoming signal flashed on March 4, with the fear gauge ultimately peaking at 60.13 on April 7. The S&P went sideways for a few weeks after the Jan. 27 and Feb. 3 signals.
That's why IBD reminds investors to use the price and volume action of the major indexes to best judge the market's condition. IBD reduced its recommended exposure level to 60%-80% after Friday's sell-off. Keep in mind, even if the latest VIX signal proves to be correct, there's higher stock market risk right now.
VIX Expert Sees Stock Market Signal
Nicholas Colas, co-founder of DataTrek Research and an expert on the VIX, also believes the index has given a positive signal. Colas says a close in the VIX above 19.5 — its long-term average — from lower levels should be considered a buy signal.
A comparison of closes above that level since 2024 shows the S&P 500 climbed 82% of the time in the one-month period following the trigger. The average S&P gain has been 2.2%.
"One month can feel like an eternity when markets get choppy, but our VIX Playbook has served us well over the years, and it is saying that U.S. large caps should bounce back in short order," Colas wrote in a report early Monday. "No strategy has a 100% win rate, but recent history says stocks recover nicely after a sudden dip that pushes the VIX above its long-run mean."
Seasonality is also a tailwind, he added, because the S&P 500 most often peaks in December during a winning year.
The major indexes on Friday suffered their biggest losses since April, with the S&P down 2.7% and the Nasdaq off 3.6%. President Donald Trump revived trade fears after he threatened "massive" China tariffs in response to that country's new curbs on rare-earth minerals. Trump followed through late Friday with an extra 100% China tariff starting Nov. 1. The president, however, struck a softer tone over the weekend, and stocks rebounded Monday.
