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Volatility Index (VIX)

The indicator series continues tonight with the VIX.  This index is a measure of volatility within real time options pricing.  It was created by the Chicago Board Options Exchange (CBOE) in 1993 and it has recently been revised (http://www.cboe.com).  It is a general market indicator and not something that you can apply to an individual chart.  It is a contrarian's indicator; this means that VIX has an inverse relationship to the market. 

 The value of VIX increases when the market declines and the value of the VIX decreases when the market rises.  Since the market is perceived by the majority as bullish the majority of the time a rising market is seen to be less risky and a declining market is seen to be more risky.  The higher the perceived risk is the higher the will be volatility.  This implied volatility is not due to price swings but rather the perceived risk associated with the market.  

 VIX is used as a contrarian's indicator.  For contrarians comparing VIX action with market action can provide a hint as to future direction of a move.  The further VIX increases in value the more panic (and panic can mean buying panic as well) there is in the market.  The further VIX decreases in value the more complacency there is in the market.  When the markets are complacent the bulls are in control and there is little concern for falling stock prices.  The thought being you can buy stocks and not worry too much about a sell off.  These stocks are not going through wild price swings and the markets are not very volatile.  When the bulls become too complacent the VIX will be at its lowest and will be indicating a possible short term market top and potentially bearish future.  

 A very low VIX reading would indicate a high degree of complacency and this is regarded as bearish.  Conversely a very high VIX reading would indicate a high degree of panic among traders and is bullish.  A high VIX reading will usually occur after an extended decline with sentiment still bearish.  

 If the market declines and VIX remains unchanged or decreases in value (towards complacency) this indicates that the decline could have further down side.  This means that there is still not enough bearishness or panic in the market to warrant a bottom.  If the market advances sharply and VIX increases in value it signals that the advance still has further to go.  Contrarians will see that as not enough bullishness or complacency to put in a top yet. 

 If you want to see what the VIX looks like at any given time the symbol to do so is $VXN on the StockChart website.(Volatility index for the NASDAQ the revised VIX).  You can also look up the original volatility index by using the symbol $VXO.  The difference is in where the option chain pulls its information from.  The old formula pulled from the S&P 100 ($OEX) options pricing.  The new index draws from the S&P 500 ($SPX).  This broader base more directly tags it as a benchmark for the entire market.  If you decide to look at this market indicator I recommend viewing it in a line chart as opposed to a bar chart.  

 The index itself is often times referred to as the investor fear gauge'.  The greater the fear in the general market the greater the volatility and the higher the VIX will read.  When stocks bounce all over the place (volatility in the market) and the crowd is in a panic this indicator will read at very high levels.  Conversely the lower the VIX reading the more complacent the crowd will be.

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