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What Is The Volatility Index Telling Us About Markets?

A closely watched indicator by many traders is the volatility index. According to Investopedia.com, "this index measures the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge"."

Since volatility tends to increase at market tops and bottoms, it is sometimes a useful exercise to check in the on VIX. So in today's Chart of the Week, let's examine both the Daily and Weekly VIX indexes.

Let's start with the weekly index.

What we can see from the VIX on a weekly basis is that 1) volatility is still low by historical measures; 2) volatility has ticked up despite flirting with market highs. This may be due to uncertainty attached to the so called "fiscal cliff" negotiations, but it is still there. Finally, 3) we can see a divergence between VIX volatility rising and stock prices also rising. Notice how the VIX started to rise in April and set a higher low in October. At the same time, stock prices hit a high on the S&P 500 in March/April and a higher high in September/October.

In my mind, this should not be possible. The VIX should be establishing lower lows as the S&P 500 hits higher highs. To me this is a warning sign!

Now let's take a look at the daily VIX index.

What we can see here is more of the same. The S&P 500 is struggling to move at its highs (or back to its highs0, while the VIX is rising. Now this may be just a temporary anomaly, but it certainly bears watching. No pun intended!!!