Almost every analyst agrees that we should expect volatility heading into next month’s election. And while I certainly find analysts’ opinions to be interesting, I always believe market action is more important to follow.

In the chart below, we see that large firms are expecting volatility to increase.

This is chart of VIX futures. These contracts track the VIX index, a measure of stock market volatility. VIX tends to rise when the S&P 500 falls.

At the bottom of the chart is an indicator based on a weekly report from the Commodity Futures Trading Commission. The Commitment of Traders report tells us who is buying gold, soybeans, and other commodities. The report includes financial futures like contracts on the U. S. dollar and VIX futures.

In the VIX market, regulators know whether a futures contract is bought by a financial services firm or pension fund that uses the futures market to hedge financial risks associated with the stock market, a hedge fund, or an individual investor. Analysts like to call this group “the smart money,” because they tend to be right about major trends more often than not. In the report, this group is called “commercials.” They include firms and funds that are properly registered as hedgers rather than speculators.

The chart above shows positions of commercials as the green line. The black line shows the positions of large speculators.

Right now, commercials are long the VIX for the first time since late last year. Because commercials are the “smart money,” this shows that risks in stocks are high. The next chart replaces VIX futures with the price of the S&P 500 at the top of the chart. The vertical line marks the 2016 election.

Just like now, commercials increased their exposure to VIX ahead of the election. Stocks declined slightly before the election — but then, in a surprise twist, they rallied sharply.

The rally caught traders and analysts by surprise. But commercials in the VIX market seemed to have seen the gains coming and they steadily decreased their exposure to VIX as the election neared.

Conclusions

This indicator provided useful market timing signals before the last election. It’s worth watching right now.

Current readings are bearish. But that could change quickly. The next chart shows the S&P 500 with my Income Trader Volatility (ITV) indicator. ITV gave a “buy” signal last week.

ITV is designed to mirror the behavior of the VIX. One way it differs from VIX is the fact that ITV offers precise “buy” and “sell” signals. “Buy” signals come when the indicator falls below its moving average (MA). In the chart, ITV is the solid line and the dashed line is the MA.

Of course, this signal could be reversed. This is a news-driven market, and the news could turn bearish as we learn more about the coronavirus cases at the White House. President Trump’s illness could move markets, as could a widespread outbreak affecting senior officials.

I’ll be watching market action closely to see how the divergence from the Commitment of Traders report on commercial positions and my ITV indicator resolves.

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