Lately, the market's been all over the place. Some call it "range bound"; others call it "volatile". Whatever you call it, the market has been nothing short of erratic. For most investors though, getting a grasp on volatility can be challenging. In this article, we'll help clear things up a little bit.

Measuring Blood Pressure
First, there is a measurement of volatility in the market: the Market Volatility Index (VIX), which is a measurement of implied volatility for the S&P 500 futures. The futures are traded on the Chicago Board of Options Exchange.

What some fail to mention in an explanation of the VIX, however, is that it is not only a measurement of fear within the markets, but also gives insight to the cost of option premiums. As the VIX rises, fear is said to have increased in the market, along with the price of option premiums. After all, those who are writing options want to be compensated for the risk they are taking on.

And, if fear levels are rising, meaning the market could become more and more erratic, option writers (sellers) need more money, given the risk of their options expiring in-the-money. All of which would mean the option writers could lose hordes of money. (To learn more, see Gauging Sentiment With The Volatility Index.)

As a value, the VIX can trade anywhere between 5 and 100; however, the VIX may trade in ranges, based the market paradigms at any given moment. Check out this information:

Historical Heart Rate
From 1991 until later half of 1998, the VIX traded with an approximate floor of about 10, but never spent much time above 30. But then, as the dotcom era took over in the late '90s, the VIX found a new range trading from roughly 20 to 50. In 2002, spikes to 50 coincided with dramatic market lows.

Then, in 2003, the VIX once again fell below 30, and has traded in the 10 to 20 range ever since, with the exception of three spikes.

One of these spikes (up to 23.81) came in the early summer of 2006. In the three months prior to the VIX topping out in 2006, the S&P 500 lost 8% from the May high. Then, this past March, the VIX again spiked over 20 to 21.25. From February to March, the S&P 500 lost 6.7%, before recovering. Most recently, on August 9, the VIX spiked to a high of 26.90, and since the middle of July, the S&P 500 has lost 8.2%.

A New Paradigm
Are you beginning to see a trend here? Actually, let me rephrase that. Are you beginning to see the current market paradigm? If the VIX falls back below 20, the current paradigm could easily continue, and investors may want to look for new highs.

However, if the VIX fires above 30, it will the first time it has done so since 2003. A spike would not immediately mean the market is going to crash, but it would infer a new paradigm.

There's one thing I've learned in my years, the market constantly changes, and we MUST be aware of the trading paradigm the market is currently facing. Thus, keeping a close eye on the VIX's range (especially given that it's at a three-year high), could help clear the air on whether things are going to get more shaky, or fall back into the old bullish range. One thing is certain: exit is everything.

For further reading on the use of VIX as a market-timing indicator, see Getting a VIX on Market Direction.

Looking to cook up a market-stomping stock portfolio? Check out our FREE report "7 Ingredients to Market Beating Stocks" and get started right now!

Related Articles
  1. Investing Basics

    Explaining Options Contracts

    Options contracts grant the owner the right to buy or sell shares of a security in the future at a given price.
  2. Home & Auto

    When Are Rent-to-Own Homes a Good Idea?

    Lease now and pay later can work – for a select few.
  3. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  4. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  5. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  8. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  9. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  10. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Derivative

    A security with a price that is dependent upon or derived from ...
  3. Security

    A financial instrument that represents an ownership position ...
  4. Series 6

    A securities license entitling the holder to register as a limited ...
  5. Internal Rate Of Return - IRR

    A metric used in capital budgeting measuring the profitability ...
  6. Board Of Directors - B Of D

    A group of individuals that are elected as, or elected to act ...
RELATED FAQS
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. How do futures contracts roll over?

    Traders roll over futures contracts to switch from the front month contract that is close to expiration to another contract ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
  6. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!