Stock market volatility is an overused phrase, thanks to the roller coaster ride stock investors have been on lately. In recent years, the concept of volatility has been the subject of much discussion, as pundits argue whether it is good or bad for the market.
So much so, in fact, that you can place bets directly on it by purchasing shares in a VIX ETN fund. What does it mean for the average investor, and is it good or bad? Should you pay attention to it, or is it just one more item to add to the noise of the market?
VIX, VXN and Other Stock Market Volatility Indexes
What is the VIX? (SP500)
The VIX is simply just the ticker symbol for the Chicago Board of Options Exchange (CBOE) market volatility index and what it does is it measures the implied volatility of S&P 500 index options.
You may hear it referred to as the fear index or the fear gauge but all it’s simply doing is measuring implied volatility but generally speaking:
The more volatile the market is the higher the VIX is and the market starts to become more volatile more erratic particularly near 20 for the S&P then the VIX started to increase in price near 30 more notably during the market crash.
Investors refer to the CBOE Volatility Index, aka VIX, as the fear index, because they mistakenly believe it represents the amount of negative sentiment among market participants. What it actually represents is the implied stock market volatility of S&P 500 futures options, or the expected amount of future unpredictability. This may sound like an oxymoron, because it represents the expected amount of unexpected behavior. The VIX goes up when predictability goes down. In other words, the VIX is high when expectations of market direction are unsure.
Market participants like smooth and steady performance. They are easily spooked by something they don’t expect and spooked investors tend to run first, then ask questions later. Because of this, stock market volatility is something investors don’t like, and it generally precipitates a flight for the exits when it gets uncomfortably high.
What is the Fear and Greed Index?
A secondary measure, which combines the VIX with several other tools that gauge investor sentiment, is the CNNMoney Fear and Greed Index, which reflected Extreme Fear just a month ago, and is showing a solid green Extreme Greed today. A chart of the index over time shows how quickly and dramatically sentiment can change.
- Visit: Fear and Greed Index on CNNMoney site.
What is the VXN? (Nasdaq QQQ)
(To pronounce it more fluently, traders call it VIXEN)
VXN allows us to have a measure of the expected risk at any time for each money invested in our preferred asset, QQQ. In response to these variations, we can set up an aggressive or defensive strategy depending on whether we are risking less or more than before.
Why is Stock Market Volatility Presently High?
Despite the numerous headlines touting new 52-week highs that the market is making, the U.S. economy is still very unstable and investors don’t feel confident that it’s heading in the right direction. Recent job reports have been disappointing, which we can blame partly on the terrible winter weather across the country, which may or may not turn around when the severe weather ends.
Financial experts point out that the market has been in an extended uptrend, with no significant correction in the S&P 500 since October 2011.
The Role of the Federal Reserve
The Federal Reserve announced in December 2013 that it would begin to taper its monthly treasury bond purchases; this process has been known as “quantitative easing,” and it has been in place since the fiscal crisis of 2007. In December, the Fed observed that the country’s economy seemed to be making some headway and that it felt the need for its stimulus would continue to diminish.
Investors took heart that this meant the economy was recovering at a decent pace, and therefore they felt more confident, so they began to position themselves for a strong market to accompany the strengthening economy.
Stock Market Volatility as Buy Signal?
One thing to note, however, is that when the VIX spikes higher, the market tends to fall, as shown here in this three-month chart. In late January and early February when the VIX went as high as 21, both the S&P 500 and the Dow Jones Industrials ETF (DIA) declined, and then recovered in the next few days as the VIX returned to more normal readings.
Therefore, investors could consider a higher reading of the VIX, combined with a fall in the markets a buying opportunity for the brave. Whatever you choose to do, be sure to arm yourself with information on investment topics like stock market volatility by taking an online investing course, such as the Investing Fundamentals Course.