Perhaps the single most misunderstood item in the financial world is the Chicago Board Of Options Volatility Index, or VIX.
The VIX is a measure of how much investors are willing to pay for portfolio “insurance.” If they’re willing to pay a lot (the VIX is high), then it’s assumed investors are nervous. If they don’t want to pay much (the VIX is low), then it’s assumed investors are calm and expecting blue skies ahead
Because of this, most investors, including the majority of professional investors, believe the VIX provides a reliable barometer of market risk.
This is not true. The reason is because investors are usually greedy when they should be fearful and vice versa. If the VIX is up, it’s not because the market is “risky” or at risk of falling… it’s because the market already FELL!
As anyone knows, the time to buy stocks is when they’re “low” as in “buy low, sell high.” But as I just explained, stocks are usually “low” when they’ve already fallen (which would mean the VIX is already spiking). Put another way, the VIX doesn’t really measure risk per se… instead it shows you when investors are panicked… and that’s when you should consider buying.
Take a look at the above chart. Everytime the VIX spiked (the blue line below), the market had already dropped and was in the process of bottoming.
Now let’s look at a longer-term chart. Once again, the VIX spiked after the market had already plunged. In fact, buying stocks around the time the VIX spiked was a GREAT way to trade the market going back for years. If you had done this, you would have profited handsomely.
If you want to make a killing in the markets, you need to be willing to see the world the way it really is, NOT how you THINK it is. Most investors think the VIX measures the market’s risk, but really, it’s almost the opposite: a spike in the VIX almost always picks market bottoms!
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