Our methodology is centered around leading indicators. We look at instruments like the US dollar, bond yields, and volatility indexes to understand the underlying trend but also any changes in the trend. We have explained in the past why volatility analysis can be powerful and even predictive. In this article, we look at one of the volatility indexes that we believe is currently forecasting volatility ahead.

The volatility index we picked out this week is the short-term S&P 500 volatility index, which we have presented in the chart below.

Every volatility index should be read in a different way. It’s not simple or straightforward. The general rule of thumb when reading volatility indexes is that they are inversely correlated to the underlying index. So, if the chart below is in a downtrend, it would imply that the S&P 500 is in an uptrend.

What we are looking for on this short-term S&P 500 volatility index are the turning points and the trend. A bullish turning point on this chart coincides with a bearish turning point in the S&P 500. Here is the caveat: finding patterns on these volatility index charts is very challenging because they move at a very different pace than regular indexes like the S&P 500.

Our annotations help visualize the trend channel: a down channel represents an uptrend in the S&P 500. As shown below, since Oct. 13, the trend in this volatility index is down.

However, we spotted a turning point in this volatility index last week. This probably coincides with a local top in the S&P 500. Our chart reading suggests that the market will move lower unless and until the downtrend on this volatility index is broken to the downside.

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