The Importance of the VIX Index

(I originally posted an article on the VIX Index on The DIV-Net website on October 19, 2008)

One market indicator that has been getting a lot of attention lately is the VIX Index (VIX) The VIX has been in the news lately since the Index has been hitting all time high levels, reaching over 89 on Friday (10/24/2008). The importance of the VIX has to do with the fact it is a measure of investor fear looking forward over the subsequent 30-day period.

(click chart for larger image)

According to the CBOE,

 

since the VIX Index introduction in 1993, VIX has been considered by many to be the world’s premier barometer of investor sentiment and market volatility. The VIX Index is an implied volatility index that measures the market’s expectation of 30-day S&P 500® volatility implicit in the prices of near-term S&P 500 options. VIX is quoted in percentage points, just like the standard deviation of a rate of return.

Additionally, one of the most interesting features of VIX, and the reason it has been called the “investor fear gauge,” is that, historically, VIX hits its highest levels during times of financial turmoil and investor fear. As markets recover and investor fear subsides, VIX levels tend to drop. This effect can be seen in the below chart in the VIX behavior isolated during the Long Term Capital Management and Russian Debt Crises in 1998.

(click chart for larger image)

An important historical aspect of the VIX is it tends to reach high levels at market bottoms. Could the current high level be signaling a market turning point looking forward? Last week's 4.7% market advance is certainly a start.

Source:

• CBOE Volatility Index White Paper VIX (pdf file)

Comments

[toobad41:]

When the VIX moved above 30 back on September 15th that was the sell date for stocks and mutual funds. Just compare the ^VIX with the S&P 500 for the last 3 or 6 months. If you were very conservative you could make a case for moving out of the market back in June or July. Regardless, it is too late to go back and do that but you can learn from that senario. Now when should we get back into the market? Just watch the ^VIX. When it starts down seriously then get back in at your earliest....when the ^VIX gets back down to 30 may be too late. Right now may be too early because we are in uncharted territory. The ^VIX may go even higher as the market goes lower.

2008 Oct 27 05:14 PM