One well-accepted gauge of "fear" in the market is the VIX. The VIX typically rises in times of market distress as options traders hedge their positions, thereby causing an increase in the price of implied volatility - leading to a rise in the VIX. Popular ETFs such as VXX are constructed to replicate the value of the VIX. Hence, a rise in the VIX typically translates into a rise in the price of VXX.
When sentiment turns positive on the VXX, it typically implies that the market is viewing that the VXX may rise and hence the "fear" factor in the market may go up leading to a potential impending sell-off in the SPY. Hence, positive sentiment on the VXX is usually negatively correlated with the market itself (i.e. the price of SPY). So tracking sentiment on the VXX can be an important part of understanding of the potential overall move in market prices.
Below, we show a chart of sentiment in social media for the VXX over the last several weeks (charts generated by Market Prophit). Sentiment started going positive on 1/16/14. Not only did this sentiment signal precede a subsequent rise in the actual price of VXX by over 1 week, but it also provided an early signal to a potential fall in SPY the following week as well. It is important to note in this example that different and unique information can exist in social media conversations that represents content particular to the stock that is being discussed. However, it is important to take into account different conversations and sentiment signals arising out of them to paint a more complete picture of potential effects of what is driving market prices. By using sentiment on the VXX itself as an indicator of "fear" building up in the overall market, it is possible to potentially get an early indicator of impending market stress that might not be reflected in the overall market yet.
VXX Sentiment and Price
SPY Sentiment and Price
An interesting thing to note in the chart for sentiment for SPY and Price, is that the moving average of sentiment started to go negative on January 24th. While this sentiment shift still preceded the further drop in the price of SPY over the next several days by almost 2.9%, the earlier signal of a sentiment spike in the VXX preceded a move of 6% in the price of SPY or an additional 3.1% above the move signaled by the sentiment for SPY itself which occurred later. Furthermore, the sentiment signal for the VXX preceded an almost 29% increase in the price of VXX itself over the same time-frame.
In the last several days, there has been another notable shift in sentiment on VXX with it squarely going negative. Again, this is an indicator of the market's change in the perception of future risk. This has again preceded a recent fall in the VXX itself as well as a rise in the SPY. Interestingly, the sentiment in social media for the SPY itself has not reversed course yet and still remains negative. However, given the behavior of sentiment on the VXX having acted as an early indicator of a rise in fear which preceded a subsequent fall in SPY, this could be another early potential indicator of a further rise in SPY above and beyond the move recently made in the last several days. The time horizon for the rise is a function of the length of time of the sentiment in the market. But changes in market sentiment as evidenced in social media can be strong indicators especially when moving averages cross the zero-mark which represents the dividing line between bullishness and bearishness. So that is a key area to watch for potential signals. Given the marketed shift in sentiment on the VXX, it seems that fear has temporarily subsided. With the jobs number coming in well below expectations, there is some conversation about the expectation of a potential slowing down of the pace of tapering. The sentiment surrounding this expectation could be one of the reasons of the recent reversal in the slide in SPY and the fall in the VXX as many view quantitative easing as a measure that lowers market volatility and removes tail risk. It is clear that the recent market price and action is a reflection of the effects of tapering on capital flows and can act as an efficient feedback loop signaling that a slowdown of the tapering schedule may be necessary. If the recent sentiment change in the VXX is any proof, it can serve as an early indication for the next run higher in the SPY.
In this example, we note that sentiment signals derived in social media can be both of a short and a long-term nature. We also note that it is important to look at multiple factors and signals generated for each of those factors when attempting to explain the price action of the overall market. Both VXX and SPY need to be monitored especially during times of larger uncertainty with particular attention to be paid to shifts in sentiment on the VXX.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.