Understanding Market Volatility and Using “VIx”

Wondering what market volatility is? If you’re going to get into investing, then understanding market volatility is essential. Volatility can be a pretty hefty term if you look at the textbook definition. For example, you might find an investor’s textbook that defines volatility as the “potential dispersion of returns for a given investment vehicle” or something along those lines.

So what does that mean? Volatility basically refers to the changes in a given investment’s value. If you take a look at a stock chart you’ll quickly see that for most stocks, prices can swing up and down. Some stocks, such as blue chips, are generally stable and only undergo gradual price swings. The same is true of indices, such as the NASDAQ.

Stocks for startups, biotechnology firms, small-pharmaceutical companies, and others can be highly volatile. Prices can swing dramatically in any given direction. And that means that you can either make or lose a lot of money within a given time. When it comes to investing, the greater the potential to produce profits, the greater the risks.

Measuring Volatility With Vix

Measuring volatility can be difficult, so many investors use tools, such as the “Vix” volatility index. “Vix” is actually a ticker symbol that refers to the Chicago Board Options Exchange Volatility Index. This index is a measurement tool used to help investors understand the market’s expectations of volatility over the next thirty days.

Quite a mouth full right? The Vix index basically uses the implied volatility of various S&P 500 stocks by looking at option prices. Options are a type of investment vehicle that give the buyer the right to either buy or sell a certain asset at a certain price within a specified time frame.

So if markets are looking volatile and investors are worried about losing money, they could buy options to sell their stocks at current prices even if prices drop. This will help investors protect themselves against volatility. It can also work in reverse with investors acquiring options with the right to “buy” stocks at current prices.

The Vix index basically allows you to understand how investors feel about markets. If the Vix stock is greater than 30, then markets are likely entering a period of high uncertainty. If the reading is less than 20, the economy is almost certainly in a relaxed, or perhaps even complacent mood.

Given that stock prices can rise or fall based on the mood and outlook of investors, the  Chicago Board Options Exchange Volatility Index is a very important tool for any wise investor. So make sure you pay attention to Vix, even if it can be a bit intimidating.

Why Market Volatility Matters

Sometimes entire markets will enter periods when they are simply more or less volatile than historical norms. For example, the S&P 500 enjoyed a long period of stability in the 90’s due to the United States’ prolonged economic boom.

In 2007, however, markets became very volatile as concerns over the U.S. housing market and various other things came to light. For a short period of time it even appeared that the entire global financial system could collapse. During that time, markets swung up and down violently, and a lot of investors lost a lot of money.

As an investor it is essential to understand what to do and how to act in both stable and volatile markets. If markets are volatile, you might want to consider reducing some of your investments, or moving some your wealth to more stable investment vehicles, such as bonds.

On the other hand, if markets appear to be stable, it might be the perfect time to expand your portfolio, or to allocate more of your wealth in higher risk stocks. Whatever strategy you development, just make sure you pay attention to market volatility.