Meet the Fear Index

I thought I was familiar with all the major stock market indexes. There's "the Dow" -- the Dow Jones Industrial Average, which nearly every news source reports regularly. Then there's the S&P 500, sporting 500 of America's biggest enterprises. And there are plenty of other ones, focusing on various large and small segments of the market.

I hadn't heard of "the fear index," though, until recently. Have you heard of it? The Chicago Board Options Exchange Volatility Index, also known as the VIX, is one way investors measure how volatile they expect the markets to be in the near future.

I looked it up at Google News, to get a feel for how this index is used and referred to. On a particular day when the Dow was sharply lower, for example, one commentator noted that as the market fell, the VIX rose more than 30% in a single day. With increased activity in options trading, particularly with put options (which let investors profit from falling prices), options prices rose in response to the volatile market movements, thereby boosting the VIX.

It seems that it's typical to see the VIX move counter to the S&P 500. When the market is jittery and falling, the VIX tends to rise. And by the same token, when the stock market seems to be chugging along and few investors are seeking out the "insurance" that options can sometimes offer, the VIX drops and fear is deemed to be low.

What to do
So now that I know all this -- and you do, too -- what should we do about it? Well, perhaps nothing much at all. After all, to a great degree, market volatility isn't a paramount concern to long-term investors. I'm invested for probably another 20 to 40 years. Does it really matter to me that the market is skittish now? Not really. If I'm planning to hold my shares of Wal-Mart (NYSE: WMT  ) for many years, as long as the company is performing well or holds the promise of doing so, then fear in the market isn't a major concern.

In addition, it's worth noting that while the VIX reflects the volatility of the overall options market for the S&P 500, that's painting with a pretty broad brush. Within the S&P 500 are many industries, each with a different volatility profile. The more tech-y industries, such as semiconductors, will always tend to be more volatile, while other industries, such as consumer packaged goods, tend to be less so.

I can hear contrary-thinking readers cracking their knuckles right now, preparing to fire off an email to me. To answer their concerns, let me note that the "fear index" can be useful -- because you can make money by being rational when others are being irrational. If fear is on the rise, and the market is getting jittery, you're more likely to see some of your favorite stocks fall into more attractive price ranges. It can be a good time to oil the wheels on your shopping cart.

So fear not, dear readers -- and happy shopping, should the market drop.

And by the way, if you're looking for some ideas for promising companies to invest in, grab a free trial of our Motley Fool Stock Advisor newsletter for a whole month, and see what our head honchos have been recommending. Their picks are up an average of 68%, versus just 29% for the S&P 500. Not bad, eh?

Longtime Fool contributor Selena Maranjian owns shares of Wal-Mart. The Fool has a disclosure policy.


Read/Post Comments (0) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

DocumentId: 524958, ~/Articles/ArticleHandler.aspx, 7/29/2014 9:43:07 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement