Maximize Profits by Harnessing Momentum and Volatility

When it comes to the stock market, there are two metrics the big end of town follow, which include momentum and volatility. In simple terms, they’re looking to identify the direction and strength of a move as the market changes from equilibrium to dis-equilibrium.

How to study the Index that tracks momentum and volatility

Momentum and volatility arise from periods of dis-equilibrium, and if we understand this we can use tools such as the volatility index to provide an indication of the direction and strength of the market. In Australia, it’s the S&P/ASX200 VIX Index that measures volatility to provide insights into investor sentiment and expected levels of market instability.

So, how can investors use this information? By studying the VIX, you can identify the sentiment of the market at any given point in time, which means you can avoid making poor decisions while at the same time potentially profiting from this knowledge.

Right now, the S&P/ASX 200 VIX has been falling over the last month, which suggests market volatility is low. Volatility is considered low when the VIX is below 12 and this month it has fallen to 8.8 and is currently sitting around 11.9.

In the last decade the VIX has only fallen to 8 or below on a few occasions and when it does the market turns bullish. This is not a blanket rule, as investors still need to research specific stocks to buy, but by researching the VIX it does give investors’ confidence that if they buy a stock the market is highly likely to support it.

What were the best and worst performing sectors last week?

The best performing sectors included Communication Services up 1.70 per cent followed by Information Technology up 1.07 per cent and Industrials up 0.42 per cent. The worst performing sectors included Materials down 1.68 per cent followed by Utilities down 0.95 per cent and Health Care down 0.58 per cent.

The best performing stocks in the ASX top 100 included Mirvac up 6.64 per cent followed by Stockland up 5.70 per cent and Pilbara Minerals up 5.47 per cent. The worst performing stocks included Mineral Resources down 6.38 per cent followed by Lynas Rare Earths down 5.99 per cent and the A2 Milk Company down 5.07 per cent.

What's next for the Australian stock market?

Over the past couple of weeks, the Australian stock market has largely been following the script I laid out in my previous reports, given that until last Friday it had fallen over seven consecutive trading days. However, on Friday the market traded up resulting in the All Ordinaries Index closing the week down just 0.29 per cent.

While I am expecting the market to be bullish this year, investors need to understand that markets don’t just trade straight up, there will be down moves like we’re seeing now. History demonstrates, that on average, the market achieves its lowest returns in May and June although there are occasions when these months are bullish.

I still believe the current move down will be short lived and I expect the All Ordinaries Index may only have one more week down. That said, we need to expect that it may fall for a few more weeks from its current level down to around 7,330 points.

Short of sounding like a broken record, investors need to remain patient over the next week or two until the market confirms it has completed its current down move. Jumping in early with the expectation that a bull market will unfold is not a wise move.

While I have said the market appears to be unfolding as expected, there have been many occasions since the COVID collapse where the market has changed in a heartbeat with volatility rising quite strongly and investors are left holding stocks that are falling in value.

For now good luck and good trading.

Dale Gillham is Chief Analyst at Wealth Within and international bestselling author of How to Beat the Managed Funds by 20%. He is also author of the bestselling and award winning book Accelerate Your Wealth—It’s Your Money, Your Choice, which is available in all good book stores and online.