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Fearful Stock Market Traders Keep Eye on VIX

20 October 2008 - Markets - Editor

After a number of gut-wrenching free falls and sharp reversals in the stock market in recent weeks, traders are hoping that tales of impending doom won’t become a reality. A lot of them are paying attention to the VIX, something that is normally considered a rather obscure index and which is generally barely worth noting.

The VIX (Chicago Board Options Exchange Volatility Index) gives insight into the volatility of the market by measuring the market swings that have been terrifying brokers up to this point. The interesting thing about the VIX is that it gives some insight into the reason behind these swings, rather than just looking at the swings themselves. For example, if the VIX is rising, it usually indicates that fear is ruling the market instead of greed. If the VIX soars, the market looks more and more unstable. If the VIX remains stable or starts to decrease it means things are improving. Unfortunately that has not been the case. The VIX rose to 70.33 on Friday – its highest close since it was introduced in 1993. Experts say that this suggests that the problems are just starting. According to Steve Sachs, a Rydex Investments trader, “it’s showing a huge amount of fear in the marketplace.”

There are people who feel that VIX has been unduly affected by the fact that increasing numbers of people are becoming aware of it in recent months. Previously the VIX was not as widely known as other indicators, like the Dow. But since it has become an almost permanent fixture on CNBC and other outlets, which comment on financial news, more and more people are becoming aware of it. This in turn adds to the anxieties that the public at large are having about the stock market, so they quickly go out and sell their stocks and that, in turn, increases the VIX. As such the VIX almost ends up being a ‘self-fulfilling prophecy’. Instead of helping, it’s adding to the problems by escalating fears every time it rises.

However, when you look at how the VIX works, it really shouldn’t cause quite so much tension. The VIX takes the amount of trading conducted throughout the day, monitors fluctuations and then makes a prediction of how much the market will swing during the next 30 days. The VIX has a very good track record and so far it has been very accurate in its predictions. However, foreknowledge is forearmed. Whereas that information could be used constructively to try and prevent these swings, people are seeing the predictions, freaking out even more and potentially making the stock market fluctuations even worse.

 


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