Did you notice the massive volatility spike on May 17? The VIX, or what many like to call the 'fear gauge', jumped 43%. That enormous move was the 7th highest all time in percentage terms. The move was largely unexpected, as most of them tend to be. We saw a big move down in volatility just after the first French election last month, the VIX stubbornly staying low. In fact, the VIX fell under 10% last week, something that had not been seen in more than a decade. Low volatility became the 'story du jour' in the business media outlets, and as usual it is at these moments when the end of that condition is nigh.
As we have all become accustomed too, the volatility fell right back down after the massive spike. For years, that has been the pattern. Human behavior rarely if ever changes suddenly, so I prefer to follow these patterns until they do change. Why is this so? Since the financial crisis ended markets have largely been in a bull trend. Lower volatility in markets has been persistent since the Fed stepped into the game back in 2009. Take a look at the VIX chart since mid 2013, and we see big spikes up in volatility have come right back down.
Zooming in a bit further, these big jumps in volatility accompany 'momentary lapses in reason', and thus the decision to bail out of stocks - always at the wrong time. But that is the herd mentality and why contrarian thinking is often the best and highest probability play. What do I mean here? Basically going against the crowd gets it done. On many occasion when investors decided to exit their trades (evident by the many circles at volatility spikes) it was actually a time to step in and buy.
How easy is to be a buyer when everyone's hair is on fire, in a panic as the Dow Industrials plunge over 360 points in a day? I trust it is not an easy task, but as history proves is often rewarded. Will there be a time when this 'buy the dip' action does not work? Of course, but until then the best action is to follow the established pattern. Again, look at the chart and see how many volatility spikes up were long-lasting, and how each and every one led to a higher market following.
The recent spike on Wednesday was sharp and scary indeed, but notice volatility retreated in a hurry. While the ideal motion was to buy into the hail storm on that day, note that even waiting a day or so for the dust to settle was just as good. Remember this down the road, as we will no doubt encounter more high volatility spike situations. Use them to your advantage.