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Volatility, volatility, volatility. It's all the financial world can talk about lately... and, well, for good reason. In the past few months, the world's stock markets have endured some of the most gut-wrenching price swings since the 2007-2009 financial crisis.
But for many investors, it's still not clear what this volatility means for the status of the bull market in U.S. stocks.
The reason why said status remains unclear is in large part because the mainstream pundits haven't exactly been consistent with their punditing. (Note: NOT a real word!)
Take, for example, this summer. Before U.S. stocks fell off the cliff this August, the market was about as volatile as a yoga retreat. The trend was a slow, calm, and steady ascension to a higher self. In fact, the ultimate "fear gauge" known as the CBOE Volatility Index (VIX) had dipped below 12 for the first time since 2014.
Now, according to the usual experts, this extended period of market calm was a bullish sign, as these news items from the time explain:
"Market Volatility Hits 2015 Low... U.S. stock investors haven't had much need for those crash helmets... It's looking like the market could be in for many more months of muted swings." (May 22 CNBC)
"Investors wo paid up for options in anticipation of volatility have lost money in the last three years, so as a result, no one is anxious to do it anymore." (May 13 Wall Street Journal)
"One of the more bullish indicators has been volatility, and it remains that way. Stocks can continue to advance as long as volatility isn't trending upward." (June 23 MarketWatch)
Got it? Low volatility is a bull's best ally.
But wait! Come August, the yoga-retreat-like market went from "Om" to "Oh My!!" via triple-digit daily leaps and losses (oh yeah, and one quadruple-digit intraday drop on August 24).
So, guess what the experts had to say about this new climate of precipitous price swings? Answer: That it's also bullish. See:
"Volatility Is Actually Good For the Stock Market's Returns" (MainStreet August 26)
"Yes, the Markets are Volatile -- That's A Good Thing... Stocks have been too nonvolatile for too long. You don't get up-a-lot markets, big moves fast, without abundant gyrations. You should expect this bull market to raise its tenacious head soon, bucking off all the fear skeptics can hurt at it."
So to summarize: Volatility down means "up" for stocks. And -- "up" is also "up"?
How about a different take altogether?
See, the mainstream experts did a first-rate job of determining that low volatility is bullish -- AFTER years of record calm. And, that high volatility is bullish -- AFTER months of record turbulence.
Elliott wave analysis, on the other hand, anticipated a historic reversal from low to high volatility BEFORE the tide turned. Here, the July 2015 Elliott Wave Financial Forecast warned "Here Comes High Volatility"
One gauge of volatility is the CBOE Volatility Index (VIX), a measure of the premium on one-to-three-month S&P options. In essence, the VIX is a sentiment measure, reflecting investors' current state of emotion, from relative calm to outright panic...
This chart confirms the deep complacency. It shows the open interest in puts relative to calls on the VIX, which indicates the ratio of investors' open option contracts betting on a VIX move. On June 19, the ratio dropped to 0.248, its second lowest level since February 16, 2007 (0.165), when the financials peaked, as just noted.
Monday's sell-off appears to be just the start. When the stock market's decline kicks into high gear, volatility will spike to record levels as will the p/c ratio. The era of low volatility will be replaced by head-spinning stock market moves that will shake global stock markets to their foundation.
The next chart captures the dramatic explosion that followed:
So, has a new era of volatility begun? And what does it mean for the U.S. bull market of the past six years?
Read our free report: Pandemonium in the Stock Market
No longer is extreme volatility contained to Greece or China. The massive waves are here in the States, just as our analysts predicted. Learn what's behind the recent market chaos. Read excerpts and see eye-opening charts from Robert Prechter's Elliott Wave Theorist, The Financial Forecast and our Short Term Update.
Fibonacci is the mathematical basis of the Wave Principle. You will often find that Elliott waves correct in terms of Fibonacci ratios. The following article explains what you can expect when a market begins a corrective phase.
If you are interested in learning more about using Fibonacci in your trading, get your free 14-page eBook, How You Can Use Fibonacci to Improve Your Trading.
Retracements -- Corrective Waves
The chart on the left shows a wave 1 followed by corrective wave 2. It is common for second waves to retrace .618 of wave 1 -- thereby making a deep retracement. Another common retracement for wave 2 is .786. You might even see .5, 50%, but .618 is more common. The chart on the right shows the most common retracement for a wave 4. Fourth waves will commonly retrace a smaller percentage or .382 of wave 3. We might also see something like .236.
Below you can see an impulsive 5-wave move on the chart of the S&P 500. Wave 2 is an expanded flat. Wave 4 is a zigzag. Let's look at the retracements that waves 2 and 4 make.
Wave 2 made a deep retracement -- close to .618. On the Fibonacci table you can see the .382, .5, .618, and .786 retracements. The .618 retracement comes in at 1087.75 and the S&P low is 1090.19.
Wave 4 made a shallow retracement of wave 3. It went just beyond the .382 retracement at 1169.1, bottoming at 1163.75.
In a nutshell, this is what we mean when we say that Elliott waves often correct in terms of Fibonacci ratios.
If you'd like to learn more about Fibonacci and how to apply it to your trading strategy, download the entire 14-page free eBook, How You Can Use Fibonacci to Improve Your Trading.
EWI Senior Tutorial Instructor Wayne Gorman explains:
See how easy it is to use Fibonacci in your trading. Download your free eBook today »