Sideways trading typically leads to sharp moves

October 20, 2006 · Print This Article

I feel like I have been so repetitive lately, but I guess that is to be expected during periods of tight range-bound markets. Options expiration was once again uneventful (as was the entire week of trading). The S&P and Dow remain in an overbought position and the VIX is back at historical lows, closing the day at 10.63.

I stated on 10/13 that ”going back over the previous year whenever the VIX reached a level this low while in an “overbought” to “very overbought” position this signaled a short to intermediate-term decline. Furthermore, I looked back to see how the market reacted when all four major indices were in a “very overbought” and this was also a good signal that a short-term reprieve was right around the corner.”

The market was in a similar situation last month. I stated in the blog during last options expiration that “historically, when the VIX reaches a level this low this usually precedes a short to intermediate-term decline and with all of the info that seems to be piling up on the bears side we should expect the same result this time around. We must remember the week of options expiration can be extremely volatile and can often fool many into adding positions that ultimately fail. Will this time be different? No one knows for certain, but with all of the information that we have sitting in front of us I can only side with the probabilities and this time (at least over the short-term) they are leaning towards the bearish camp. Only time will tell.” The market traded sideways during September’s week of option expiration only to move lower the following week.

By the looks of it we could see a similar short-term reaction next week. However, it would not surprise me to see a breakout to the upside early in the week before the correction comes. Typically, when the market trades in a tight range like it has over the last six sessions we will see a breakout ,which in most cases, is a false move. Have a great weekend!

RSI Wilder (5) for October 20, 2006