Continuing our discussion of indicators, such as VIX and VXN, as well as what support and resistance are. (December 2, 2001)
The VIX and VXN are measures of volatility of the market by looking at hypothetical at the money options on the S&P 100 and Nasdaq 100, respectively. Options have as one of their pricing components volatility. There are a few ways to calculate it, but in short it is nothing more than a measure of how much the underlying index the option covers is expected to move.
We look at the volatility indexes because one of the things volatility can show us is investor fear and investor complacency. High levels of volatility usually accompany fear in the market. When is there a lot of fear? When selling is strong. If the volatility measure gets high enough, historically it has been an indicator of bottoms in the market. On the other hand, when investors are not scared at all and volatility falls to levels that historically show a lack of fear, the marekt can be topping. Everyone is invested, everyone feel's the market will keep going up, and there is nothing else left to drive the market higher. We can also, however, see high volatility at tops as well, but that usually starts after some sharp selloffs; lots of up and down action ratchets volatility back up at the market top.
We discuss the levels of volatility that are important in the summary as comparisons for what we saw that day. We look for extremes once again because this is a sentiment indicator. Extremes either way can lead to opposite reactions in the market. This is another topic that we cover in our online seminar series that we will be airing again starting in January.
We will touch on support and resistance this coming week.
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