By :
Echievements
Three rudimentary measurements provide stock market guidance for investors.
VIX
Volume
Price
Momentum
I'll explain three of the four.
Stock prices are easy. When a buyer asks for a price and a seller makes a bid, the mediator of the trade (let's use a New York Stock Exchange Floor Trader) brokers the transaction. The New York Stock Exchange reports the trades, combines them with other trades (electronically), and reports a price or value for a listed corporation's stock. If the stock is "up", the ticker reads "green"; if the stock is "down"...well, you get the point. Pretty simple market when thought of in basic terms. The more buyers, the higher the stock price; the more sellers, the lower the stock price ("Doh").
Volume indicates interest (or lack of interest) in a company's stock. Investors attracted to a specific company's stock (or stock market index) want to see the stock/equity go up with strong, heavy, potent volume. In the words of William O'Neill (founder of Investor's Business Daily) the "elephant needs to get in the bathtub with you" because the elephant (the large institutional buyer or a massive number of buyers)lifts the price of a stock the way an elephant would raise the water in your bathtub.
Every transaction has two viewpoints. The buyer thinks he can invest with optimism; the seller thinks he should divest with pessimism. Obviously, one is right; the other is wrong.
The VIX (Chicago Board Options Exchange Volatility Index,) measures and tracks stock market optimism and pessimism. The VIX also tells us when most investors are wrong or apathetic. Greed and fear are the prominent expressions of the VIX.
When the VIX is low (see the table below), greed behaves presumptively thinking "the sky is the limit". When the VIX is high, investors fulfill their nightmares believing "the sky is falling". On October 9, 2008, the sky was falling.
Date: VIX Open: VIX High: VIX Low: VIX Close: Dow Close:
October 9,2008 57.57 64.92 52.54 63.92 8,579.19
October 9,2007 17.96 18.68 17.54 18.22 14,164.53
During the past couple of weeks, most doctors would not be impressed with our EKG given our perceived stress. The VIX has an EKG too, and you can read the chart in the Ethos Blog comment "When The VIX Is Hot, The Healing Begins".
Four academics (Antognelli, Ferreira, McArdle, and Traub)wrote the research paper, "Fear and Greed in Global Asset Allocation" in The Journal of Investing (Spring 2000). They assert, the VIX "is a good indicator of the level of fear or greed in U.S. and global capital markets. When investors are fearful, the VIX level is significantly higher than normal."
Larry Connors article, "A Volatile Idea". Futures Magazine (Jul 1999): p. 36—37 references the "Many indicators such as the advance/decline line, put/call ratios and the Trin (the advance/decline ratio divided by advancing/declining volume ratio), (that) are used by traders to measure market sentiment."
Connors underscores the predictive characteristics by considering the VIX "....the best (index) available to capture the pulse of the market..." He suggests that VIX levels can alert investors to "quick reversals" in stock market direction. This information serves the option trader (If you want to learn more about options, visit the Chicago Board of Options Exchange website). The higher or lower the VIX level, the quicker investors react.
One way to understand the VIX is to observe the titles academics use to describe the Chicago Board of Options Exchange Volatility Index.
Fleming, J., B. Ostdiek, and R. Whaley, 1993, "Predicting Stock Market Volatility: A New Measure", Duke University working paper. Go ahead and download You may download this paper "Predicting Stock Market Volatility: A New Measure". The paper is 38 pages in Adobe Acrobat Format (pdf).
The authors state, "...the volatility index indeed appears to be a useful proxy for expected stock market activity." (page 2) Tracking of the VIX began in 1986. There are a number of dates presented in this paper; I'll tell you about the October 1987 VIX moves since you will remember October 19th 1987. "The October 1987 stock market crash is accompanied by an end-of-week volatility level in excess of two and a half times the next largest historical level". On October 23, 1987, the VIX closed for the week at 98.81.
Here are other articles referencing the value of the VIX as an indicator of market volatility and reversal. These articles are available to subscribers of the journal or publication.
Whaley, Robert E.,1993, "Derivatives on Market Volatility: Hedging Tools Long Overdue," Journal of Derivatives 1 (Fall 1993), pp. 71—84.
Whaley, Robert E., 2000, "The Investor Fear Gauge," Journal of Portfolio Management 26, pp. 12—17.
Erin Arvedlund authored the article, "Calm Before the Storm? Low Volatility Often Precedes Market Downturn." in Barron's Jan. 28, 2002 issue.
Dan, Kopin. "Volatility Index Continues Climb, Closes at Highest Level in 14 Years" Wall Street Journal, (Jul 24, 2002); pg. C.11.
Whaley, Robert E., 2000, "The Investor Fear Gauge," Journal of Portfolio Management 26, pp. 12—17.
When fear exceeds sensibility, markets often and usually reverse. When greed exceeds everything your grandmother taught you, markets teach lessons.
Now, does the VIX tell us the exact point of a reversal (one way or the other)? I think not. It does tell us when we are close, or about to experience a change in market direction, and this is what makes the VIX useful.
Just remember something Barton Biggs said to a Bloomberg television reporter today, These markets are "irrational and mad". "Conventional wisdom (suggests that) we'll have the mother-of-all bear market rallys." His point: the expectation thwarts the possibility; only despair turns bear markets. Just don't let the despair take over your heart or mind.
Author Resource:-
Ray Randall is a registered investment advisor. Investing really is all about you when you apply time-tested asset allocation methods. Take action by asking for a complete review of your portfolio here.
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