Dear reader,

I read my emails with fascination last week as a few South African Investor “Pillar One” Advisers, namely Alexander Green and Marc Lichtenfeld, debated about the importance of tuning out the media “noise” and the constant flow of bad news and how best to go about it. The two went back and forth on this issue all week. But finally when I checked my email yesterday morning, I discovered they’d come to a conclusion on the topic. They advised that you pay attention to real indicators like earnings (which are good) and investor sentiment (which is bad).

Great advice! But easier said than done I'm afraid. And while I was mulling over this issue, a gem of an email hit my Inbox. It was from a colleague of mine in our American office, Karim Rahemtulla. Karim’s an expert at reading the markets and what his email had to say on the topic really hit the nail on the head!

I just had to share it with you…

********************************
Do you know when to buy and sell your shares? This indicator will tell you...

After you've read this article, the next time someone asks you, “Hey, how's the market looking?” you'll know what to say - and sound smart saying it!

Not only that, the information I'm about to share with you will also give you a valuable clue as to when to buy and sell your stocks.

No, I’m not talking about taking your cue from other investors and blindly following them. Quite the opposite, in fact. The strategy I’m going to reveal to you will underline the importance of having contrarian instincts when it comes to investing.

But how can you tell what investors are feeling and the general mood of the market? Simple...

The best way to gauge investor behaviour

The CBOE Volatility Index (VIX) is a measure of market sentiment, based on options trading among the S&P 500 companies.

In short, if more people are buying put options (shorting the option) than call options (buying), they're betting that the market will head lower. As a result, the VIX will rise, indicating fear in the marketplace.

Conversely, if more investors are buying calls than puts, they're predicting that the market will head higher and the VIX will fall amid perceived investor complacency.

As you can see below, the VIX and market volatility were trending higher a few weeks ago. But you can also see that the rise in volatility wasn't nearly as pronounced as it was in May after the infamous "flash crash".

More recently, the VIX hasn't confirmed the S&P 500's move from the 1,100 level down to the 1,040 level. And as it stands now, the VIX is about 40% lower than it was when it spiked to 37.58 on the 1st of July.

Translation?

Are you watching the "Head-and-Shoulders?"

Basically, there's an underlying bullish sentiment in the market. For evidence, the S&P 500 recently set what technical analysts call a "head-and-shoulders" pattern – a very bearish signal for the market. But the VIX didn't confirm this pattern and, lo and behold, the market rallied again.

Head-and-Shoulders pattern

As the name suggests, this is a chart pattern that bears resemblance to a person's head and shoulders.

You can spot the pattern easily, as it will show two lower peaks (the shoulders) either side of a higher one (the head).

It's marked by the price first rising to a peak before declining, thus setting the first "shoulder". The price then rises again, above the first peak, which establishes the "head". The price then falls again. The final step - i.e. the second "shoulder" is another rise in price to roughly the same level as the first "shoulder".

Here's what to watch for next...

Interpreting the VIX: When to buy and sell your stocks

Right now, the VIX is trending lower. This is important because if it continues in that direction - and into the mid- to upper-teens - you'll want to start selling. Why?

Because each time the VIX has traded in the mid-teens, it's represented a major opportunity to short the market, since that level has historically proved to be the bottom of the volatility range.

And that range - if we ignore only the most extreme bullish and bearish events as aberrations - is between 13 and 49.

* At 13: This means investors are very complacent and you should short the market.

* At 49-Plus: This means investors are panicking – this is when you want to start buying quality shares.

Take the market's pulse every day

Now do yourself a favour...

If you're not tracking the VIX, do it. All you need to do is visit this site each day. While there is no 100% accurate way of predicting what the market will do, it certainly pays to have indicators that can help you gauge investors' moods and the market climate.

The VIX is my favourite way of doing so and it's proved to be the most reliable indicator of the market's future moves over a short period of time.

And don’t forget to watch our very own South African Volatility Index (the SAVI) too.

According to Red Hot Penny Shares analyst and regular MoneyMorning contributor, Gareth Stokes, “the index was designed to measure expectations of three-month market volatility and is the benchmark for measuring market sentiment. Traders jokingly refer to it as the ‘fear’ index”.

Here’s how it works: “When daily market returns are sufficiently volatile, the SAVI tends to spike upward, reflecting a higher level of implied volatility or expected risk. That means there’s a greater sense of fear in the markets under these circumstances. A clustering of sufficiently low market returns is associated with low levels of volatility. This is reflected in equally low level of the SAVI. Under these circumstances, the expectation or fear of risk is low."

So what are we seeing right now? As Gareth put it: “Right now, the SAVI is off the charts – fearful investors are sitting on the sidelines until the volatility dies down a little.

Food for thought – and definitely something you need to consider when trying to figure out whether to buy or sell right now.

Here’s to your financial freedom,

Karin Iten and Karim Rahemtulla
For Money Morning

****************************
Know of a colleague or friend who will benefit from today's Money Morning?
Forward this email onto them so that they too can start taking advantage our brilliant investing commentary. And if they want to subscribe all they need to do is click here!

*******************************
If you really like our service, why not tell us about it? We'd really appreciate
you leaving a testimonial! Just click here.

*******************************
PRIVACY POLICY: “We HATE spam, possibly more than you do. That’s why we will never, EVER pass your details on to any third party companies. That’s a promise.”
****************************
Since Money Morning is completely free email, we necessarily fund our operation with occasional – and carefully selected- advertising and offers. All of these opportunities are ones we believe you will find interesting.  However we will keep our promise and NEVER give your email address to any other companies.
*************
Copyright (c) 2010 Fleet Street Publications Pty (Ltd)

You are receiving this email because you have given us permission to contact you.

Unsubscribe from this e-letter? If you do not wish to receive further such emails, please click on the link

Do you have a query? Please do not reply to this email. Messages to the sending address will not be seen by customer services. All email correspondence should be sent to: queries@fsp.co.za Customer Services 0861 114 365.

Syndication

If you'd like to put Money Morning articles on your website, for free, please email - syndication@fsp.co.za.

IMPORTANT: We do require that: 1. You ask permission first, 2. That you do not use our articles until we have confirmed that you can, and 3. That you clearly attribute any article you use to us, and paste a link back to www.fsp.co.za.

Disclaimer: There is no magic formula to getting rich in the stock market. Like all forms of investment, success in selecting stocks with the best prospects for price appreciation can only be achieved through proper and rigorous research and analysis of publicly available company and industry filings and news releases. The opinions in this advertisement are just that, opinions of the author.

Warning: Stock/option trading involves high risks and you can lose a lot of money-you may even lose all the money you invested. So please, do not invest with money you cannot afford to lose. Past Results are not necessarily indicative of Future Results

The information in this email is confidential and may be legally privileged. It is intended solely for the addressee. Access to this email by anyone else is unauthorised. If you are not the intended recipient, any disclosure, copying, distribution or any action taken or omitted to be taken in reliance on it, is prohibited and may be unlawful. If you are not the intended recipient please return the message to the sender and delete it from your records. Alternatively, please contact Fleet Street Publications Pty Ltd on Customer Services 0861 114 365.