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What To Do When Stocks Go Down? Hint: Watch VIX

After the recent minor market corrections largely due to inflation fear, I have seen so many people discussing and asking what they should do with their losing positions on various online forums. I feel for them because I used to be one of them.

This doesn’t mean I don’t hesitate any more and just close my positions whenever they reached a pre-determined exit point. I still do hesitate, but now I have various reference points to help my decision-making easier.

Stock market corrections happen more often than we think. A quick Google search shows that a market correction that is at least a 10% decline happens every 1.87 years and smaller ones occur much more often. This is why most people just want to buy and hold because it is just too much to stomach such market ups and downs this often.

 

stock market correction how often

For options traders like us, we don’t have the luxury of closing our eyes, look away and just stay put for the long term. This is why the tools discussed in the following could give us reference points as to how much further the market is likely to fall.

What To do When Stock Market Goes Down?

There are four tools that I use to calm myself down and look for signs of the market hitting the bottom.



Video Demonstrating These Four Tools

Tool #1 S&P 500 Chart

Nothing special about this one. Just a simple chart reading to check on the trend, where the support/resistance lines are, and any short-term chart pattern that could give some indications on how much further it is likely to fall.

Tool #2 VIX Chart

  • VIX Implied Volatility vs Historical Volatility
  • VIX, VIX9D ratio
  • VIX, VIX3M ratio

VIX is derived from S&P 500 index options and it provides 30 days forward volatility projection of the market. VIX9D looks at 9 days volatility projection and VIX3M looks at 3 months volatility projection.

VIX is generally negatively correlated to S&P 500 so by observing the IV & HV of the VIX and ratios between VIX and these volatility indexes, we could get a sense of how long the storm is going to last and when it is likely to turn around.

Another reason that I observe VIX closely is that I trade VIX-derived ENPs such as VXX and UVXY.

Link to download the TOS Chart File >>

VIX chart

Tool #3 VIX, VIX9D, VIX3M, & VVIX Chart

By doing a simple subtraction between VIX with VIX9D, VIX3M, and VVIX, we could get a sense of how bad the volatility spike is. By comparing the current spike against historical spikes, we could get a sense of the velocity of the spike to gauge if the current market downturn is likely going to be a large one, or just a “blip”.

Link to download the TOS Grid File >>

VIX, VIX9D, VIX3M, VVIX grid

Tool #4 $VOLD, $ADD, $TICK

Market internals gives us insights into the volume and price movement of stocks that are listed on NYSE.

$VOLD: The sum of buying vs selling volume. If the overall volume is green, it indicates there is more volume for buying stocks rather than selling and vice versa.

$ADD: The number of stocks that had higher or lower prices compared to the prior market day.

$TICK: The sum of the number of stocks rising vs the number of stocks falling.

Link to download the TOS Grid File >>

VOLD, ADD, TICK

Any Thoughts or Suggestions?

Obviously, it is not possible for us to predict the future but using these four tools could give us a “sense” of which way the market is going to move next. We could scale back our positions if the tools indicate that the market downturn is likely to be a large prolonged one, or jump back in if the tools are telling us otherwise.

Do you have a tool that you use to monitor the market or to help you calm down during a market crash? I would like to hear them. Please share them in the comment.

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