Though it seems like the VIX should measure investors’ notions of future risk, in practice it is mostly just a measure of the market’s recent performance. It is highly correlated with historical volatility, based on the standard deviation of S&P 500 moves over the past 30 trading days, or how far the index has tended to swing daily. The strongest message the VIX is sending is that the drop in stocks hasn’t been particularly severe, as, indeed, it hasn’t.”VIX Signal on Stock Selloff Is Yesterday’s News

The Wall Street Journal, April 11th 2014 (access requires subscription)

Within the past year the CBOE Volatility Index has gone from being talked about literally every day by the financial media, to being ignored at best and sometimes disparaged for being inconsequential. 

Although it’s true that movement in the VIX is usually coincident with movement in US equity prices rather than being a leading indicator, we think it is still a valuable indication of when investors should be paying particular attention to near term US stock market movement. This appears to be one of those times now. 

The black bars in the lower panel of the chart below plots the VIX daily since the beginning of the year along with its 50-day moving average (blue line). The red highlights show that sustained moves by the VIX above the 50-day moving average, indicating a significant increase in investor fear, have coincided with minor declines in the S&P 500 (SPX, upper panel) in late January/early February and in early April.

The green highlights show that failed attempts by the VIX to rise above the 50-day moving average on April 28th, May 7th, and May 15th all coincided with near term bottoms in SPX. The green arrow in the lower right edge of the chart points out that another such test of the 50-day MA from below is taking place this week. 

So, although the VIX may not be able to tell us where the S&P 500 will be tomorrow or at the close on Friday, it is telling us that if the 2014 US stock market advance is still healthy and intact, it should begin another minor leg higher from right here, right now, as the VIX retracts from its 50-day moving average. 

Conversely, more strength in the VIX that results in a sustained move above its 50-day MA at 12.96 would warn that another counter-trend decline is emerging.