Most of us are well aware of the VIX.
It’s the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the stock market’s expectations for volatility in a 30-day period. It’s constructed by simply using the implied volatility of S&P 500 index options. It’s not based on actual volatility. Instead, it’s based on market expectations.
That’s the confusing way to explain it, though.
In short, it’s simply the market “fear gauge” or its “blood pressure.”
It’s typically driven by geopolitical crises, politics, disasters, even fear over what the Federal Reserve may or may not do. It tells us how confident or fearful traders are.
For example, in recent days, the VIX was as low of 9.31.
We haven’t seen it that low in about two decades. Then again, there’s good reason for the low, as U.S. stocks climb on economic hopes and the realization the Federal Reserve isn’t likely to act again any time soon.
For comparison, during the financial crisis of 2008, the VIX roared to 80 – a powerful indication of intense fear on the markets.
However, low points on the VIX should be watched, especially when it drops under 10. Once it becomes too low, it’s a reflection of dangerous complacency. It begins to imply that every one is far too bullish on the markets.
Historically, each time the VIX drops under that threshold, we begin to see spikes in the VIX not long after. Those spikes can result in fear-based pullbacks on the major indexes for example.
In fact, the last time the VIX closed under 10 in late June 2017, the VIX exploded from a low of 9.75 to 13 in days, resulting in a pullback in major indices. The Dow Jones for example slipped from a high of 21,535 to 21,197 not long after.
In early May 2017, the VIX hit a low of 9.57.
Not long after it jumped to more than 15.71, as the Dow fell from 21,000 to 20,553.
There may not be a lot of science behind the “fear gauge,” but it is still worth paying attention to if you’re attempting to gauge potential market direction.