What Is The VIX Index? – Forbes Advisor UK – Forbes

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Published: Oct 10, 2022, 8:47am
The financial world has been awash this year with stories of volatile stock markets producing challenging and turbulent conditions for investors and their portfolios alike.
Headline-grabbing news makes good reading, but what does all this mean? What is volatility, how is it measured, and can it actually be predicted?
Here’s what you need to know.
Remember: investment is speculative and your capital is at risk. You may lose some or all of your money.
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The share prices of companies listed on stock market indices such as London’s FT-SE 100 or the S&P 500 in the US move up and down daily in response to all manner of prompts: everything from government announcements and the latest economic data, to international news and geo-political events such as Russia’s invasion of Ukraine.
As share prices rise and fall so, in turn, does the stock market. Volatility is a measure of the intensity of all these fluctuations and can apply either to individual company shares or the market as a whole.
A company’s share price is ultimately determined by the amount shareholders are willing to pay for it. In turn, investor appetite is based on company-specific factors as well as wider stock market and economic conditions and levels of investor optimism.
One way of looking at volatility is to regard it as a measure of how much the price of an asset, such as a company’s share price, jumps around over time, both in terms of the speed and the frequency of those moves.
Perhaps because of its name, there’s a prevailing sense – often mistaken – that volatility is always associated with negative connotations in relation to the business of investing.
In fact, volatility is a neutral term representing a statistical measure of price changes (see below).
Greater volatility just means that an individual share or the index itself is experiencing bigger than average price changes – higher or lower – over shorter periods of time.
For short-term traders, market volatility provides the opportunity for larger gains – and, of course, losses. It also allows investors to take advantage of low share prices and affords them a chance to ‘buy the dip’.
Investors can manage volatility by investing over a long period of time. This should have the effect of smoothing out short-term spikes and dips and deliver an average return over a period.
Volatility can, however, be a problem for investors who need to sell their shares at short notice, or for those in or approaching retirement who don’t have time on their side while waiting for prices to recover.
In contrast to the concept of ‘risk’ – which can be subjective and difficult to articulate in absolute terms – volatility can be both quantified and measured.
Volatility is measured in terms of a mathematical function known as ‘standard deviation’. This considers how much the returns of an investment move away from, or deviate, from their average. Investments with a high level of volatility move further, and more frequently, away from their average returns.
When it comes to investing in stocks and shares, no one has invented a crystal ball that can predict the fate awaiting companies and investors.
But there are indicators that have, in the past, helped investors to anticipate events such as major stock market shocks.
Several signals trace their roots back to US stock market behaviour. For example, the Chicago Board Options Exchange Volatility Index, usually shortened to the VIX (and also referred to as the ‘fear gauge’) is a measure of the expected volatility of the US stock market.
The VIX is designed to reflect professional investors’ views of future volatility. It gauges how much one of the world’s most important stock market indices, the S&P 500, could fluctuate over the coming 30-day period. The higher the VIX rating, the more fearful are investors.
Market professionals refer to these fluctuations as ‘implied volatility’. This is because the VIX tracks the options market – a market where traders make bets about the future performance of market indices such as the S&P 500.
For people watching the VIX, the belief is that the S&P 500 acts as a proxy for wider stock market activity.
When the VIX moves higher, this reflects the fact that professional investors are responding to more price volatility in both the S&P 500, in particular, and markets more generally. 
If the VIX slips lower, investors are essentially betting there will be smaller price movements within the S&P 500, which implies calmer trading conditions and less uncertainty.
It does this by tracking the trades that are made in so-called S&P 500 options. Options are a complex type of contract-based investment used by institutional investors, such as pension funds, as insurance to protect their portfolios. 
This means they can enjoy positive returns regardless of whether the market eventually goes up or down. The VIX follows these trades to gauge market volatility.
Generally speaking, if the VIX index stands at a score of 12 or lower, the market is regarded as being in a period of low volatility. A score of 20 reflects abnormally high volatility. Once the VIX exceeds 30, that’s viewed as an indication that the markets are very unsettled.
The VIX currently stands at 30 (7 October 2022), a fair bit lower than 36, which it reached at the start of the war in Ukraine.
To put the numbers into context, October’s current level is nowhere near the spike of 82 that the VIX registered at the start of the Covid-19 pandemic, when global stock markets crashed.
Nor is it close to the average level of 57 that it continued to maintain through March and April 2020 as the worst effects of the pandemic started to play out and markets took fright.
That said, the VIX’s historical average tends to be around the 20 level. Sustained periods above 30 suggest turbulent times, a scenario that investors currently will be all too familiar with.
As a stocks and shares investor, if you see that the VIX is moving upwards then it could be a signal of rising volatility in the markets. To counter this, you might consider shifting some of your portfolio to assets that traditionally tend to carry less risk, such as bonds.
Alternatively, you could change the asset allocation within your portfolio and convert more of your holdings to cash to weather an investment storm.
However, for those worried by the current levels of volatility, trying to anticipate when a jittery market is going to end – with a view to scooping up investments at bargain prices – is not necessarily a wise idea. That’s because there is no way to know when a market has actually reached its lowest level.
That’s why taking a long-term view is usually the best strategy. Time in the markets, rather than timing the markets, is the secret to riding out daily ups and downs.
A sensible approach, for the rest of 2022 and beyond, might be to drip feed smaller amounts into your investments either monthly or quarterly, no matter what the price is at the time.
This not only makes you disciplined about investing on a regular basis, but also minimises risk by ensuring you invest during the lows, when equity prices are cheaper, as well as the highs.
This strategy takes advantage of ‘pound-cost averaging’, which cushions some of the effects of volatility by averaging out the price you pay. This has the result of making your investment costs lower over the long-term while, hopefully, improving the likelihood of securing a decent return.
It also removes the emotion that is so often tied to investing. This means you can focus on life’s other priorities rather than continually worrying over the state of your investment portfolio.
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