How to Interpret the VIX

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The VIX is a two-headed dragon.
The VIX is a two-headed dragon. (Image: Photos.com/Photos.com/Getty Images)

One of the best known volatility indicators for the stock market is the Chicago Board Options Exchange Volatility Index (VIX). The VIX is a dynamic measure of the implied volatility based on the prices of options of the Standard & Poor's 500 index. What is not as well known is how to interpret the VIX. In general, when the VIX spikes higher it means that fear is gaining traction in the market; conversely, when the VIX is dropping, it means investor confidence is growing. This article will offer methods of interpreting the VIX and using its readings to your short-term trading advantage.

Go to your favorite financial website and find the latest reading for the VIX.

Compare it to its most recent levels. If the VIX is moving up from its recent value, the broad market is most likely moving down. It moves in the opposite direction of the overall market because fear is growing. If the VIX has been spiking higher, like it did in late 2008, it would likely mean that the market is selling off because fear has gotten the better of investors. If the VIX is dropping, investors' confidence is high and they may be complacent.

Be prepared to buy or sell depending on the direction the VIX is moving. When the VIX is spiking higher as fear grips investors, it may be a good buying opportunity as the market approaches a bottom. If the VIX is declining relative to its recent value, it could be indicating that a short-term top in the market has been reached and the prudent investor should be prepared to sell all or part of his position.

Use the VIX to gauge fear and confidence in the market but always keep in mind that no single method or metric can consistently predict the market's direction.

Tips & Warnings

  • Though the VIX might make new highs or dive to new lows, it does not necessarily predict a long-term market top or bottom.

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