Hi all, I've stumbled upon a pattern that seems to play out when the hottest new major crisis drops.
I've color-coded the various sections on this pattern, and I'll attempt to give a breakdown of each. Let's begin.
Stealth Phase - Grey
In this phase, it seems that the market is performing some sort of rally, and so the VIX lowers a little bit. During this, the cause of the recession is known to very few. These insiders may make large selling moves into the rally, but otherwise, it's impossible to tell that anything is wrong. Lehman Brothers on the verge of collapse in 2008, the Covid virus not being taken too seriously in 2020, and today's Fed Tightening being dismissed by talking heads and the generally optimistic.
Initial Impact - Red
Once the bad news really gets broadcast and sinks in, the market drops a bit. This causes a steep incline on the VIX, signaling (of course) higher volatility. This initial impact is followed by more spikes, noted on the chart in a lighter red. In 2008 this was the Lehman Brothers collapse. In 2020, it was around the time that the first Covid case was announced in the USA. Today, this is the collapse of Silicon Valley Bank, Signature, and Credit Suisse.
Immediate Return Rally - Orange
The extremely optimistic, those in denial, and the ones wanting out, will rally the market into a higher state. This, in turn, causes the VIX to shrink back down. The VIX may in fact shrink to its previous levels, before the initial impact even came around. In 2008, this rebound came about after Lehman collapsed. In 2020, this was mid-January to mid-February. In 2020, this is where we are now. Total dismissal of the collapse of some very large banks, and a plea for higher highs.
As a side note, I do find it amusing that the past few days have seen such a large market rally. It just happens to be that the end of the quarter, when large money managers are trying to get their bonus, that we see such a severe rally. In fact, we've seen the S&P 500 seem to break out of its major resistances. While this is usually bullish behavior, I personally discredit this move as a classic pump-and-dump. While we may see the markets move higher by another couple percent, it is more likely that these managers are done calculating their bonuses and will rush to withdraw their profits. Retail traders will likely be left holding the bag as next week's conditions rapidly decline.
Back-To-Back Selloffs - Yellow
Once the rebound enthusiasm of the market wears off, the selling really kicks in. The first leg down catches unprepared traders by surprise. A fluke, they think. And so we see them catch the falling knife. But when this pressure doesn't let up as well as they thought it would, a second wave of selling proceeds.
Relief Rally - Green
After taking a major beating, the resistance of the market comes to head. We find a temporary bottom due to the oversold nature of things, and a relief rally is in order. The optimistic, once again, will see this as the bottom and even as we continue back down the move will be dismissed as a double-bottom.
Return to Panic - Turqoise
It seems that as we proceed past the double-bottom, the market becomes confused on which direction it should go. Accelerate or decelerate? This brief period seems to be different.
Crown of Despair - Cyan
Yes, finally, our journey is at an end. This is marked by not one, or two, but three distinct spikes in the VIX as it tops out. This signifies our market bottom, at least for 2008 and 2020.
Road to Recovery - Blue
The road to recovery is a bumpy one. After we've reached market bottom, the VIX seems to pop higher once more and then take a break. After this, there are three distinct pops in the VIX as we return back to normal market conditions. The middle of these three seems to be a bit more drawn out.
While this chart certainly can't predict the future, it is very interesting to see the clear similarities between 2008 and 2020. Not to mention the similarities both of those have to today's market. The psychology of the market during a large downturn is extremely hard to predict. There have been many crashes in the market that don't follow this highly specific model. 2000's Tech Bubble, for example, does come very close and appears to have all of the pieces- but things are a little more distorted, and perhaps overlap each other. The "Crown of Despair" in that case is malformed and, admittedly, just a single spike. I would have liked to test this theory on some other major crashes, but the VIX indicator was only introduced in 1993.
What are your thoughts?
I've color-coded the various sections on this pattern, and I'll attempt to give a breakdown of each. Let's begin.
Stealth Phase - Grey
In this phase, it seems that the market is performing some sort of rally, and so the VIX lowers a little bit. During this, the cause of the recession is known to very few. These insiders may make large selling moves into the rally, but otherwise, it's impossible to tell that anything is wrong. Lehman Brothers on the verge of collapse in 2008, the Covid virus not being taken too seriously in 2020, and today's Fed Tightening being dismissed by talking heads and the generally optimistic.
Initial Impact - Red
Once the bad news really gets broadcast and sinks in, the market drops a bit. This causes a steep incline on the VIX, signaling (of course) higher volatility. This initial impact is followed by more spikes, noted on the chart in a lighter red. In 2008 this was the Lehman Brothers collapse. In 2020, it was around the time that the first Covid case was announced in the USA. Today, this is the collapse of Silicon Valley Bank, Signature, and Credit Suisse.
Immediate Return Rally - Orange
The extremely optimistic, those in denial, and the ones wanting out, will rally the market into a higher state. This, in turn, causes the VIX to shrink back down. The VIX may in fact shrink to its previous levels, before the initial impact even came around. In 2008, this rebound came about after Lehman collapsed. In 2020, this was mid-January to mid-February. In 2020, this is where we are now. Total dismissal of the collapse of some very large banks, and a plea for higher highs.
As a side note, I do find it amusing that the past few days have seen such a large market rally. It just happens to be that the end of the quarter, when large money managers are trying to get their bonus, that we see such a severe rally. In fact, we've seen the S&P 500 seem to break out of its major resistances. While this is usually bullish behavior, I personally discredit this move as a classic pump-and-dump. While we may see the markets move higher by another couple percent, it is more likely that these managers are done calculating their bonuses and will rush to withdraw their profits. Retail traders will likely be left holding the bag as next week's conditions rapidly decline.
Back-To-Back Selloffs - Yellow
Once the rebound enthusiasm of the market wears off, the selling really kicks in. The first leg down catches unprepared traders by surprise. A fluke, they think. And so we see them catch the falling knife. But when this pressure doesn't let up as well as they thought it would, a second wave of selling proceeds.
Relief Rally - Green
After taking a major beating, the resistance of the market comes to head. We find a temporary bottom due to the oversold nature of things, and a relief rally is in order. The optimistic, once again, will see this as the bottom and even as we continue back down the move will be dismissed as a double-bottom.
Return to Panic - Turqoise
It seems that as we proceed past the double-bottom, the market becomes confused on which direction it should go. Accelerate or decelerate? This brief period seems to be different.
Crown of Despair - Cyan
Yes, finally, our journey is at an end. This is marked by not one, or two, but three distinct spikes in the VIX as it tops out. This signifies our market bottom, at least for 2008 and 2020.
Road to Recovery - Blue
The road to recovery is a bumpy one. After we've reached market bottom, the VIX seems to pop higher once more and then take a break. After this, there are three distinct pops in the VIX as we return back to normal market conditions. The middle of these three seems to be a bit more drawn out.
While this chart certainly can't predict the future, it is very interesting to see the clear similarities between 2008 and 2020. Not to mention the similarities both of those have to today's market. The psychology of the market during a large downturn is extremely hard to predict. There have been many crashes in the market that don't follow this highly specific model. 2000's Tech Bubble, for example, does come very close and appears to have all of the pieces- but things are a little more distorted, and perhaps overlap each other. The "Crown of Despair" in that case is malformed and, admittedly, just a single spike. I would have liked to test this theory on some other major crashes, but the VIX indicator was only introduced in 1993.
What are your thoughts?
