Although we rarely do it, it's something every trader should at least do every now and then. What I'm talking about is looking at monthly charts. That sounds like forever, I know, especially when your typical holding period is less than a month. But, it can be very enlightening, and a nice reminder of what's really going on in the market.

In fact, the current chart of the CBOE Volatility Index (or VIX) is an outstanding example of why it pays to take a step back and look at the bigger trend. Using a daily chart alone, it would be easy to forget that the VIX is at record low levels. But when we started doing a routine review of monthly charts, there were some enlightening things that appeared. So today, we'll focus in on the underlying shift the VIX seems to be poised to make.

First and foremost, we want to stress that we're not viewing this monthly VIX chart as bullish or bearish. We're just discussing some observations about where the VIX looks like its going (although we do have a couple of thoughts about the bullish or bearish implications below). Our primary goal today is to make some sort of forecast about the kind of environment the market could provide investors in the near - and not so near - future. 

The Volatility Index is getting..........more volatile

Back in last 2003, once the market's recovery finally started getting some traction, the VIX finally broke under its range of 16 to 50 (marked with red dashed lines). The interesting thing is, it did so pretty quietly. Since then, things have gotten a little more wild. Even though the actual VIX readings have been dropping, the support and resistance lines (blue) have been widening. All things being equal, that range should have narrowed. Of course, all things are never equal. There are two important things to note about this. First, that widening trading range will make it that much more difficult for the VIX to actually break out of it. It progressively has more room to dance, so to speak, so a big move wouldn't necessarily have to break that bigger downtrend. Second, we have to wonder what this means for the future. We know that periods of high market volatility are followed by periods of low market volatility. But can the same be said about the VIX? Probably. If so, we're looking for the VIX to become less volatile (relatively) in the foreseeable future.

The question is one of when. When will the VIX's range start to shrink, rather than widen? Possibly when that support/resistance range is broken and a new uptrend is started....which could still be a while.

The implication is just that we can't misinterpret what appears to be a big reversal in the long-term trend for the VIX. That resistance line is currently at 17, and falling. Until that line is breached, don't get too excited. Take a look at the chart, then read on for our further comments.

S&P 500 versus VIX, with MACD of VIX - Monthly

The Tide Is Indeed Turning

Despite the fact that the VIX is still trapped under resistance, we're seeing something here that we haven't seen in a long time. The MACD chart on the bottom portion of the image is actually a MACD of the VIX (not the S&P 500). As you can se (highlighted), the momentum here turned upward in early 2005. The entire chart looks alarmingly similar to the one we saw in 1993. In both instances, the VIX was coming off of long-term lows near 10, while the market had been through a period of mediocrity. In 1994 - after the VIX's MACD crossover - stocks went wild, and the VIX followed through on its upward push. I'm always hesitant to draw parallels, but at the same time, this one is too similar to overlook.

Of course, the issue becomes one of whether or not the economy is capable of a recreating that red-hot stock rally of the late 90's. Like I said above, we're not making that particular forecast today. But, we wouldn't rule it out. I seem to recall a lot of broad and long-term pessimism in the mid-90's - the same kind that we're seeing right now. The market climbed that wall of worry like it had never had before, so it wouldn't shock me to see it happen again...........if only because very few people think it can.

In any case, the momentum for the VIX has already shifted upward. Once that resistance at 17 is breached (and new VIX highs start being made), I suspect that we'll see a different tone for the market. I don't know if it will be bullish or bearish, but I do think it will end this period of choppiness, and allow for bigger and longer trends.

When it's all said and done, perspective is still everything

Keep in mind that we're looking at monthly charts here. Our use an interpretation will differ with a daily chart. From a daily perspective, extreme highs still signal a market bottom, while extreme lows still signal a market top. The thing is, you have to be careful about how you define 'extreme'. In the late 90's, a VIX reading of 30 was normal. Today, a VIX reading of 30 would literally be off the charts. You absolutely have to figure out what kinds of VIX readings are pushing the limits (we prefer Bollinger Bands to do that).

But what about our monthly chart? Well, the bullish/bearish arguments become a little less relevant here with a monthly look. Instead, the indicator regains its true nature with a monthly chart - as a gauge of expected volatility. And historically speaking, its pretty accurate. The low VIX of the early 90's accompanied a midd bull trend, while the rising VIX in the late 90's ushered in a volatile bull market. Even when the market crashed, the VIX stayed high, properly indicating that stocks were going to be volatile, but not indicating which direction that volatility would push them. And even now, as the VIX has been inching lower, the bigger bull trend has been quite tame. The point is, as a volatility gauge, this long-tem VIX chart has proven its accuracy.

Which brings us back to an earlier point........about whether or not the VIX chart is bullish or bearish. On a daily chart, and even a weekly chart, yes, we still use the VIX to spot reversals. But on this monthly chart, it's clear that a high or rising VIX can be bullish. Just see 1994 for proof. Your timeframe should determine how you interpret the VIX.

Bottom Line

Although we talked about a lot of VIX details today, the reality is that we really didn't say much. Why? There are a lot of things that we'll be keeping an eye on here, but none have come to fruition yet. Namely, we want to watch for the point when the VIX finally breaks that resistance line. We suspect things will start to get interesting then. And again, that doesn't have to be a 'bigger picture' bearish event; it could be bullish too.

In the meantime (from a short-term perspective), a rising VIX may be just what the trading doctor ordered. Stocks have been remarkably inconsistent in 2005, mostly as the result of a lack of conviction on either side of the market.......and as foreseen by a record-low VIX. A return to the more volatile days where the VIX would spike and plunge on a regular basis would really go far in getting some trade opportunities on the table. These opportunities would be both bullish and bearish, and certainly welcomed by all the traders who are waiting for some much needed swing trends. But until then, it may pay to be selective about the battles you choose to fight.

We plan on diving in deeper to a few of these ideas between now and the end of the year, as we take a closer, detailed look at the VIX chart (and other indicators). Be sure to stay tuned.

Price Headley is the founder and chief analyst of BigTrends.com.