How You Can Profit From 'The Index Of Fear'
As any investor can attest to, things are not always what they seem. Take volatility in the. It's bad, right?
There is an often-misunderstoodthat tracks the 's volatility called the . Basically, the measures the implied volatility of the S&P 500 over the next 30 days.
Sound like mumbo jumbo? Not so fast.
You may have heard of this index on CNBC or in the financial press. If you're like me, you may have discounted it as some type of complex indicator for option traders only, with no relevance to the market.
Not only does the VIX help project movements, it is easy to interpret using a few little tricks.
The VIX was first used in 1993. It's built upon an idea credited to Professor Robert Whaley. The VIX is a weighted blend of prices for a range of options on the S&P 500. The options are based on the expected volatility or over the next 30 days. Think of options as an insurance policy. Insurance is priced based on the likelihood of an adverse event occurring.
Simply variance rate for the next 30 days.) The number has been as low as 9 and as high as 89 during the financial turmoil in 2008., the higher the VIX, the more professional traders believe that take a downturn. The number of the VIX represents the annualized expected percentage down move of the S&P 500 over the next 30 days. (If you are mathematically inclined, the VIX is calculated as the square root of the
View it as the S&P 500down. As the VIX moves higher, the S&P 500 moves lower. When the VIX moves lower, the S&P 500 generally travels higher. The VIX is called "the fear index" for a reason. The higher the fears in the market, the more traders their positions with options, driving up the price of the options, therefore the price of the VIX.
Now that you understand what the VIX is, how can an investorit to work?
Professional traders don't use the VIX as a static number but in relation to its 10-day simple moving average.
Author Larry Connors calls this "the 5% rule." Whenever the VIX is trading 5% below its 10-day simple moving average, the S&P 500 has lost basis five days following. The opposite has also been extensively tested and proven accurate. Whenever the VIX has been 5% or more above its 10-day simple moving average, the S&P 500 has earned returns better than two to one compared to the average weekly returns of all weeks.on a net
On a relative basis, the VIX is signaling overbought and oversold conditions. In other words, the edge is in buying stocks when the VIX is at least 5% above its 10-day simple moving average. In addition, sell or don't buy stocks when the VIX is at least 5% below its 10-day simple moving average. It's the time-proven, buy-the-fear, sell-the-greed axiom at work in this professional stock trading tactic.Â
TheAnswer: Remember the VIX whenever you are thinking about buying or selling a stock. See where it is in relation to its 10-day simple moving average and use this data to help your decision.Â