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Cramer: Rare pattern in fear index means S&P rebound will continue

Whenever investors panic and stocks start to fall, there are certain tools Jim Cramer uses in order to gauge the situation. Right now one of those tools is showing promising signs for stocks moving forward.

The CBOE volatility index, called the VIX or fear index for short, measures how much volatility investors expect in the S&P 500 in the short-term. Many investors use it to measure the overall level of fear that exists in the market.

"At the end of the day, the Brexit was a real bad idea, but the VIX says the lion's share of the damage, at least to the U.S. is now behind us," the "Mad Money" host said.

To gain further insight, Cramer spoke with VIX expert Mark Sebastian, a technician and founder of OptionPit.com, and colleague at RealMoney.com.





"The Brexit was a real bad idea, but the VIX says the lion's share of the damage, at least to the U.S. is now behind us" -Jim Cramer


When Sebastian looked at the VIX in isolation, it didn't tell him much. That is why he often compares it to the S&P 500 as the best way to hunt for bottoms and spot a top in the stock market.

Typically when the S&P 500 goes down, volatility will go up because fear will rise. Likewise, when the S&P goes up, the VIX tends to go down as a basic inverse correlation.

Sebastian discovered something strange when he looked at the charts from late May and early June. He found that as the S&P rallied, the VIX did, too. Usually when that happens, Sebastian says, something is wrong.

"It is a pretty reliable sign that the market is gearing up for a potential sell-off," Cramer said.

Cramer interpreted the fear from the VIX during this time as investors being anxious about the Brexit vote ahead of time. Ultimately the VIX turned out to be a better predictor of the Brexit referendum results than the actual polls, which suggested the U.K. would vote to remain in the EU.

Looking at the charts from the past few trading days, things got very bizarre. On Monday, the S&P plunged 1.8 percent, but rather than going higher, the VIX actually went down dramatically to indicate the level of panic was receding. According to Sebastian, that is a very rare occurrence.

"In Sebastian's view, that is often a sign that we are approaching a bottom," Cramer said.

The good news is that Sebastian was confident that the rebound on Tuesday could be the real deal. If another shoe drops, the market could go lower, but the action in the VIX made Sebastian believe that the averages are ready to roar.

So, as long as the market isn't blindsided by a new disaster, Sebastian thinks that the S&P could continue its rebound going forward and the Brexit damage could be done.

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