The VIX: Use It Right
One of the few market timing indicators that professionals pay close
attention to is the Market Volatility Index–more popularly known as the VIX.
TradingMarkets’
Market Bias Page features a collection of proprietary market timing
indicators that are based on an application of the “reversion to the
mean” principle to the VIX
(
VIX |
Quote |
Chart |
News |
PowerRating). This simply means that the VIX is
most useful when the index hits an extreme relative to recent history. This is
the most reliable way of using the VIX to time major moves in the stock market.
Most traders, however, look at the VIX more simplistically. They look for the
market to make tops when the VIX is low. Conversely, they look for market
bottoms, when the VIX reaches a high. The big problem with this is that the VIX
is in a continual process of readjustment, and this approach, over the course of
time, is not reliable.
Still, recent market action illustrates the power of the VIX and how, once in
a blue moon, the market will make a major turn at an extreme in the VIX. As you
can see in the following two charts, the recent downturn in the Nasdaq was
foreshadowed by an extremely low reading of 18.13 in the VIX.
My purpose in showing this to you is not to teach you the wrong
way to use a great indicator. As you can readily tell, other extreme readings in
the VIX over the course of 2000 did not coincide with tradable tops and bottoms.
The lesson here is that this is one powerful tool. To benefit from it, you must
use it correctly.
See you tomorrow,