Pundits are obsessing over the CBOE Volatility Index, saying its very low levels suggest the stock market is near a top. While the VIX is useful at finding market bottoms, it is not that good at finding tops. The indicator, in fact, has been even lower during rallies in the past and higher when the market actually did find its peaks.

More interesting is that the Standard & Poor’s 500 index is now in its tightest percentage range since September 2014, which was just ahead of a sharp correction to the downside. Granted, the Ebola scare was in the news then — which could have affected trading — but the tight range did indeed portend the explosive move that followed.
While the S&P 500 itself now trades in a tight 2% range since early July, the so-called Bollinger Bands suggest that noose has tightened further (see Chart). These trading bands, named after their discoverer John Bollinger three decades ago, are a mainstay of any technical analysis and charting software package. They draw an envelope above and below trading action based on volatility rather than a fixed value or percentage, allowing them to expand during volatile times and contract when things are quiet.

When the bands are as narrow as they are now — roughly 1.5% — they tell us the market is preparing for a significant move. Bollinger posited that volatility cycles from high to low and back to high again, much like price does. Thus a quiet market will likely give way to something more exciting.

Unfortunately, the bands themselves cannot tell us the market’s likely direction. We will need other tools to make that forecast.

Bands this narrow are a rare occurrence. The S&P 500 saw bands this tight in 2006 and 2012 — and did suffer corrections both times. However, the previous occurrences in 1993 and 1995 instead saw steep continuations of the bull market that was already in effect.
Why is the market so tight? There are many theories, from the end of the summer to the unusual political season. Yet the most likely explanation is uncertainty about the Federal Reserve’s timetable to raise short-term interest rates. Opinions on the merits of a rate hike are quite strong on both sides.
From a charting point of view, the reason does not matter. All we need to know is that the market is very quiet right now — almost too quiet — and that cannot last.

To be sure, other indexes such as the Nasdaq 100 and the small-cap Russell 2000 are narrow but not at historical levels. The large-company S&P 100 and the Dow Jones Industrial Average mirror the S&P 500, and that is enough for me to conclude that the market is poised to move.

Given the very low VIX, weakness in income-oriented sectors creating a divergence with the rest of the market, and a yield curve that continues to maintain a flattening trend, it would seem that a significant decline is more likely than a significant gain.

Depending on what Fed Chair Janet Yellen says later this week, we may have to wait for a breakout or breakdown before determining the next directional move. It is that anticipation that is sure to make the normally quiet last weeks of August as exciting as it gets.

Michael Kahn, a longtime columnist for Barrons.com, comments on technical analysis at www.twitter.com/mnkahn. A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.