The VIX Indicator

by Investment U

The VIX Indicator The Investment U E-Letter: Issue # 347

Monday, June 21, 2004

The VIX Indicator: Know When To Buy and Sell

By Dr. Steve Sjuggerud, President, Investment U

The most important thing happening in the markets right now is actually no thing... as in, nothing...

I can't remember such a boring time to be an investorLast week, the Dow Industrials gained a boring six points a 0.06% return. Right now, as I write (Monday morning), the Dow Industrials are down 0.29% since the beginning of the year. Boring!

Stocks have done nothing. And bonds have done nothing also, as investments in both corporate and government bonds with long-term maturities are down about 1% this year. Commodities in general are up a bit this year, currencies are down a bit versus the dollar, and the big winner (up 9% by one measure) is U.S. home prices.

Still, there's no drama anywhere. (I'd bet the commission-based stockbrokers and financial planners are having a heck of a time as nobody is buying anything, and nobody thinks they need any help right now)

The big question is: What should we be doing as investors to counter such a boring market? We'll consider one answer today

Boredom's Yardstick... What the "VIX Indicator" Says Now

Boring markets are accompanied by low volatility in stocks. For example, the Nasdaq Index - an index known for its riskier tech stocks - is currently at around 2,000. It's spent nearly all of this year in a range between 1,900 and 2,100. Now that's boring - that's low volatility.

There is an excellent gauge of stock market volatility. It's (imaginatively) called the Volatility Index, or VIX for short. The symbol is ^VIX on Yahoo! Finance (http://finance.yahoo.com/?u). Don't forget the "^".

How the VIX Indicator is calculated is less important than what it tells us about our money

How to Use the VIX Indicator

The old saying with the VIX is, "When the VIX is high, it's time to buy." When volatility is high and rising, that means people are scared. When people are scared, they sell, and stock prices fall dramatically.

The smart thing to do is wait for peaks in the VIX (levels above 30 on the VIX are starting to get high), let the VIX start to decline, and then consider buying. As volatility declines, stocks rise and you can make big profits. You see it time and again.

In the last few years, up until this year, the message, "When the VIX indicator is low, it's time to go," has worked. When the VIX has dipped below 20, it's been a good time to lighten up your exposure to stocks. It happened in late 2000, in mid-2001 and in early 2002, and the signal was very good.

The Case for a Rise in Volatility - And a Fall in Stocks

In 2004 the VIX has been below 20, but using it as a signal wouldn't have made (or lost) you much money (remember, it's a boring market).

Right now, the VIX is at 15. Its lowest close since 1996 was 14, and that occurred earlier this year. So volatility can only really go in one direction: up. At some point, probably very soon, volatility will rise - and judging by the VIX's historical record, stocks will fall.

Simply put: When volatility rises, stocks fall. And volatility can't fall much lower So, therefore, stocks may not rise much higher until volatility returns to normal.

So the most important "thing" to understand right now is no thing that nothing is going on right now. And the smartest thing you can do is recognize this, and recognize that it never stays this way. So position yourself accordingly.

Today's IU Cribsheet

Good investing,

Steve

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