Stock market volatility continues to shock most market participants this fall with enormous swings occurring almost daily. On Thursday, the Dow was down almost 300 points at its worst levels only to recover with a massive 552-point gain. That’s an incredible 850-point turnaround in the span of just four hours of trading.

The Dow, however, dipped under its October 27 low of 8,176 while the S&P 500 Index was far below its 848.92 low last month.

The CBOE Volatility Index, which measures options traders’ sentiment on the S&P 500 Index, plunged 10% to 59.83 (see above chart). That’s still a highly elevated level with the VIX in record territory since Lehman’s collapse in mid-September. In 2008, the VIX has surged 113% and has gained an average 73% annually since November 2005.

An extreme VIX reading continues to suggest stocks are seriously oversold. Other market sentiment indicators remain highly stressed, including investment advisor sentiment (highly bearish), high cash levels at mutual funds and hedge funds and record equity fund and hedge fund redemptions. With everyone heading out the door at the same time over the last 60 days contrarian investors believe stocks can post a major rally off the recent lows.

Since September 1, the Dow has crashed a cumulative 24% while the S&P 500 Index has plunged 29%. Worse, the MSCI Emerging Markets Index has collapsed, down a dizzy 39%. Over the same period gold prices have declined 12% while the euro has tanked 13%.

Just where the stock market is heading next is anyone’s guess. From one day to the next it’s like watching a wild rollercoaster; big price swings are indicative of a major transition ahead to either a bottoming process and then higher stock values, or worse, the next leg down for this bear market. It just seems that every time we have a big rally the sellers always tend to emerge.

I suggest investors remain highly defensive. It’s just not worth chasing this market. Remember, we are entering a “soft” economic depression as suggested by Swiss money-manager, Felix Zulauf. I embrace this view.

The economic news is still deteriorating and despite an oversold stock market, corporate earnings don’t look encouraging as global demand falls off the charts this fall. Any big rally should be viewed as an opportunity to sell unwanted stocks and raise shorts or reverse-indexing positions.

If you’re adamant about bottom fishing at these prices, consider going into the market carefully through income producing securities like bombed out convertible bonds, investment grade corporate bonds and TIPs. These are all highly attractive segments of credit right now and still miles below their highs following a major crash in September and October.

On Monday I’ll review credit markets, including LIBOR, commercial paper, credit default swaps (CDS) and other important measures of credit to decipher exactly where we stand at this point in the financial crisis.

Thank you for all your comments on this page. I receive a handful of commentaries each day and I’m delighted investors come for their daily fix. I enjoy your feedback.

See you on Monday. Have a good weekend.