Fly Fishing the Stock Market: How to Search for, Catch, and Net the Market's Best Trades

THE INFLUENCE OF VOLATILITY

Regarded as the “Fear Index,” the index of volatility is a technical measurement of the degree to which prices fluctuate above and below a mean, or average. When the volatility is high and the range of price swings widens, investment returns show a greater dispersion than average.

As a result of this, a direct and significant relationship exists between market prices and volatility. As volatility declines, the stock market tends to rise, and as volatility increases, the market tends to fall.

Because volatility has such a direct and strong impact on prices, it is important to accurately assess it on a routine basis. How do we do that?

Hans Wagner offers this suggestion in an article he wrote for Investopedia:

One way is to use the CBOE Volatility Index (VIX). The VIX measures the implied volatility (IV) in the prices of a basket of put and call options on the S&P 500 Index. The VIX is used as a tool to measure investor risk. A high reading on the VIX marks periods of higher stock market volatility. This high volatility also aligns with stock market bottoms. Low readings on the VIX mark periods of lower volatility. The periods of low volatility may last several years and are not as good for identifying market tops. The VIX is intended to be forward-looking, measuring the market's expected volatility over the next 30 days.

Wagner concludes the article by saying:

The higher level of volatility that comes with bear markets has a direct impact on portfolios. ...