In 1993, a new measurement for the index of volatility for the S&P 500 stock index came out with the purpose of measuring fear and greed. It is called the “VIX”. If the VIX index goes up, the traders and investors may be heading for the exits. Conversely, if the VIX goes down, confidence and optimism are restored, money is coming off the sidelines and moving into equities.
We can't trade the VIX directly but the VIX is traded on the futures exchange and can be traded just like any other investments. In general, VIX values greater than 30 are generally associated with a large amount of volatility as investors are fearful of uncertainty; VIX values less than 20 associate with less volatility and less stressful in the market.
On the other hand, when the VIX is consistently below 20, it means that the underlying S&P is in overbought position and it is due for a correction and vice versa.
There are 4 variations of the volatility index: the VIX tracks the S&P 500, the VXN tracks the Nasdaq, the VXD tracks the Dow Jones Industrial Average and the RVX tracks the Russell 2000. Investors can trade VIX futures for hedging purpose. For example, if VIX starts to rise, it means the level of fear and uncertainty is increasing and you may purchase VIX futures contracts on the Chicago Board Options Exchange (CBOE). If the market does indeed start to sell off and the VIX rises, the profits gained by the VIX futures can help to offset some of the losses that you might experience in other investments.
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