{"id":11949,"date":"2010-08-11T15:46:12","date_gmt":"2010-08-11T19:46:12","guid":{"rendered":"http:\/\/countingpips.com\/fx\/?p=11949"},"modified":"2010-08-11T15:46:12","modified_gmt":"2010-08-11T19:46:12","slug":"stock-market-investing-the-latest-news-about-volatility-and-the-vix","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/fx\/2010\/08\/11\/stock-market-investing-the-latest-news-about-volatility-and-the-vix\/","title":{"rendered":"Stock Market Investing \u2013The Latest News About Volatility and the VIX"},"content":{"rendered":"

By Richard Gunderson<\/strong> – By its very nature, stock investment<\/strong> involves dealing with volatility. For many, the term “volatility” has a negative connotation particularly when it pertains to financial assets. The dictionary definition of volatility is readily understood. In the world of stock market investing<\/strong>, the meaning is not as clear. For the person sitting on the sidelines asking “how do I start to invest my money<\/strong>“, the presence of volatility in the stock market<\/strong> looks like “shark infested waters”. For the experienced investor, volatility is often considered a good thing that can be used to the investor’s advantage.<\/p>\n

This article will clarify what volatility is all about when investing in stocks<\/strong>.<\/p>\n

Definitions:<\/strong><\/p>\n

Webster’s Dictionary defines volatility<\/strong> as “likely to shift quickly and unpredictably; unstable; explosive”.<\/p>\n

When it comes to stock investments<\/strong>, there are two forms of volatility: historical volatility and implied volatility.<\/p>\n

Historical volatility<\/strong> is considered a measure of stock price swings over time. Large variations in price over time is considered high volatility. Small variations in price over time is considered low volatility.<\/p>\n

Implied volatility<\/strong> is the volatility as currently estimated by a stock’s option price. High implied volatility means the market expects the stock to continue to be volatile (ie. to continue to make large moves). Low implied volatility means the market believes the stock price moves will be conservative. In the options world, implied volatility has a bearing on changes to the option value. This is beyond the scope of this article.<\/p>\n

One key factor about volatility is that it is not a directional indicator. Whether the volatility is high or low, any measure of volatility is not an indicator of the direction a stock price will move. However, taking other factors into consideration, volatility may help to predict the future direction of movement of a stock’s price.<\/p>\n

The Chicago Board Options Exchange defines the Volatility Index<\/strong> (VIX) as “a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index<\/strong> option prices. Since its introduction in 1993, the VIX has been considered by many to be the world’s premier barometer of investor sentiment and market volatility<\/strong>“. The VIX is used by many investors as a measure of risk and they refer to it as the “investor fear gauge”.<\/p>\n

To better understand volatility, we need to look at it from a bigger picture point of view.<\/p>\n

Volatility Is A Fact Of Life:<\/strong><\/p>\n

Frank Holmes, CEO and Chief Investment Officer of US Global Investors, recently reported that, “in the past 400 years, there have been 47 major credit currency crises”.<\/p>\n

However, we must differentiate volatility from crises. Volatility, in the context of large price variation, exists independently from financial crises. Volatility exists to some degree in all market conditions, independent from crises. In fact, most stocks and stock indexes exhibit consider swings in price variation multiple times every year.<\/p>\n

According to Frank Holmes, 70% of the time over the past ten years, the rolling 12 month price action exhibited the following price swings:<\/p>\n