It's time to head for the exits.
In April, we bought stocks in anticipation of a short-term rally. If you followed my recommendation to buy, you're sitting on solid gains.
But now, the Volatility Index (the "VIX") is signaling it's time for us to sell and take profits.
Let me explain...
The VIX is Wall Street's fear gauge and an excellent contrary indicator. We buy when the VIX makes an extreme move to the upside (when people are scared). We sell when the VIX makes an extreme move to the downside (when people are complacent).
Take a look at this chart of the VIX plotted along with its Bollinger Bands...
The red circles on the chart indicate times when the VIX fell below its lower Bollinger Band and then closed back above it. Those are "sell" signals.
As you can see, we got a new "sell" signal on Tuesday.
Up until Tuesday, there had only been two over the past year. Each one was followed by a modest decline in the S&P 500 of 2%-5%.
So this isn't the time to be looking at buying a bunch of new long positions. The stock market is extended to the upside and is ripe for a pullback. So it's time to take profits on our trade and move to the sidelines.
But this also isn't yet the time to be aggressively putting on short trades. We will likely see a pullback in the broad stock market over the next several sessions. So having some exposure to the downside makes sense.
But I can't make a strong argument for loading up on short positions just yet.
The S&P 500 rallied to a new all-time high Tuesday. The momentum is still on the side of the bulls. The index needs to fall and then bounce to form a lower high before we can get bearish.
Don't get me wrong... the stock market is extended and set up for a pullback. Aggressive traders can try to profit on a sharp, quick move to the downside. But the declines following the two previous VIX sell signals were too mild to produce large, intermediate-term gains on the downside. I'm not convinced the current setup will be any different.
So for now, it's best to move to the sidelines and wait and see how this "sell" signal plays out.