This post is not so much about a spread betting strategy but an indicator that can be used to predict when the markets (share markets) will turn. The VIX index AKA the Fear Guage is a good indicator to use when spread betting shares. At present the markets are getting quite frothy, rampant even. The reasons for this include the massive injections of money into financial systems in the western world. It has given some people watching the markets ‘the shivers’, as quoted by Alan Abelson on Barron’s.

So what’s the VIX index and how can it be used for spread betting

Share markets are often said to be driven by fear and greed. It’s comes down to crowd psychology where there’s an event that makes everyone either greedy and wanting to invest buy more, or fearful of the future causing ‘the crowd’ to sell like crazy.

The VIX index measures expected volatility in markets by using clever algorithms based on the options market. In basic terms options can be used as a form of insurance by professional investors against a large drop in the market.

How can the VIX index be used as part of a spread betting strategy?

Spread betting relies on market volatility. Share prices must be moving either up or down for a spread trade to become profitable. As an gauge of expected volatility the VIX index is great at indicating when market will turn. Not exactly when, but it’s enough to focus the attention. Combined with traditional and simple spread trading techniques such as looking a price charts, simple moving averages and volume of shares traded it forms a powerful indicator.

A low reading on the VIX index is an indication of calm in the markets. What spread traders watch out for is a sharp reversal in the index. This would foretell a sudden change in sentiment which is a high probability indicator that markets will drop. Quickly and by large amounts. A high reading indicators significant fear in the market and normally accompanies lows points in the market.

What is the VIX index telling spread traders now?

Currently bullish sentiment in the market is running high. With markets having risen consistently for months investors start to get complacent. Bullish sentiment peaked just before the crash in 2007. In July 2007 both professional and retail investors where very bullish and the fear gauge was at all times lows; a reading of around 10. It spiked up and the markets turned.

It’s not quite as low as it was just before the crash in 2007 but it’s not far off. What this tells spread traders is that the winds may be turning and bulls may be heading ‘off a cliff’. Spread traders need to ready themselves for a reversal.

What are the charts telling us?

Taking a look at a long term chart of the FTSE 100 it shows us that the market is nearing the peaks reached during 2007 just before the previous crash. Long terms charts are great for identifying major turning points in the market. The one below is a free chart from ADVFN (advanced financial network) of the FTSE 100.

Free chart for spread trading

From the chart it’s easy to see that the market has peaked twice from then end of the 1990s to now. The last was July 2007. At the two previous peaks the VIX index was very low. It’s got to drop by about another 10 points to equal the previous peak levels. This indicates that the bulls have further to run but not far.

The upper black line on the chart marks the previous resistance points. The upper resistance line indicates where the next market top may lie. Looking to the top right of the chart it shows that the next point of resistance will be roughly 6200, around 300 points higher than we are now, which is where the price could meet resistance. This marks a massive psychological level which is a high probability turning point for the market. At that point the VIX index would be around 10. Watch this space.

What can charts tell us about how the market will progress?

Spread trading strategies use different techniques at predicting the future. Charts are a good way to get an idea of what might happen and can be used to place spread trades accordingly. It should be used as a means of opening high probability trades, but, shouldn’t be seen as a crystal ball.

Below is another chart, courtesy of ADVFN, that shows how the market might progress either in it’s journey up to previous highs, shown in green, or how it might resume the march downward shown in red.

Free chart of the FTSE 100

The annotations on the chart show a flag pattern. It’s a pattern that is repeated time and time again in the markets. The price bounces of the lines of resistance (top) and support (bottom) until volume increases and the momentum causes the price to break out upward (green) or downward (red). These are points where an order should be placed with a spread betting company to either open a buy or sell spread bet. The order should be placed a little way up from the resistance line or below the support line so as to make sure it is a significant move.

This is an example how the VIX index can trigger a spread trader to look at some charts to start placing orders for high probability spread trades. A buy order is a buy spread bet that is opened when the price gets to a pre determined price set by the trader. A sell order is sell spread bet that will be opened when the price passes down through a predetermined level set by the spread trader. In case of uncertainty regarding order types a good place to learn more is with the spread betting companies themselves. Spreadex have some great promotions right now.

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