Stock Market for Beginners

The CBOE Volatility Index (VIX) is a great way to figure out when it is safe to put money into this volatile market. The VIX measures the market’s expectation of short term volatility conveyed by stock option prices of the S&P 500. Because volatility means financial turmoil, the VIX is often referred to as the “investor’s fear gauge.” At the CBOE website, you can learn more about the VIX and how it’s calculated.

Why is it important to be able to gauge the amount of fear in the market? Because fear historically means lower prices and the lack of fear means higher prices. As a good investor or trader, you should be buying when fear is high and prices are low and selling when fear is low and prices are high. So, by tracking the VIX, it can be determined when fear is at extremes signaling opportunities to buy or sell.

Presently, the VIX is high if you compare it to its average for the past three years. The VIX closed at 20.74, its highest level since we had the low in the S&P 500 in March and higher than the levels we reached last summer. The last couple of times the VIX reached these levels, it signaled a buy for the market because fear and selling was at extremes. You can see from the VIX and S&P500 charts the correlation between VIX tops and S&P bottoms. It is hard to say that the market is a buy right at this moment, but if history repeats itself, we could well be near a bottom.

When using the VIX as a buy signal, it is safer to wait for the VIX to show signs of turning downward and volatility expectations to decrease before you start to buy the market. Trying to pick the top in the VIX and a bottom in the market can be very dangerous. Some people refer to picking bottoms as “trying to catch a falling knife.” Experienced investors know it is safer to commit your money after a bottom has formed.

It is hard to say that today was the top in the VIX and the bottom in the market, but if you keep tracking the VIX, it will give you signs of the ultimate bottom.

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