The VIX measures market volatility by gauging how many put and call options are being bought and sold on stocks in the S&P 500. Many believe the VIX is a leading indicator, but it isn’t. The VIX is a lagging indicator. It reacts to what is happening in the market. People begin to use it as a real-time measure of what is going on. That can be effective in the short term, as it is a direct and accurate reflection of the market.
You can use the VIX all the time. It is one of the many indicators that allow you to gauge the direction of the market, how fast it’s moving, and how much panic or complacency exists. Complacency can last for a long time. Panic does not.
Between 15-25
The sweet spot for the VIX is its historical range, between 15 and 25. It’s not normal for the VIX to trade below 15 and stay there. The lower it trades, the less normal it is.
Between 10-15
A reading between 9 and 15 reflects market complacency; it’s a warning sign if it stays there too long.
Below 10
If the VIX drops below 10, you should be looking over your shoulder. In the fourth quarter of last year, the VIX traded below 10. A reading that low should really scare the heck out of you. It means investors are a little too relaxed. In these situations, you should buy puts because when volatility is low, options are cheaper. As volatility increases, stock prices will nose-dive and you’ll be able to profit from the market drop.
Between 25-30
When the VIX is trading between 25-30, the market is experiencing above-normal volatility. This is when you should start dipping back into the market. It’s also when you should sell options to collect higher premiums.
Between 30-40
When the VIX is between 30-40, we are entering a mini correction. Start buying more stocks and selling more puts.
Between 40-50
When the VIX moves between 40-50, a very rare occurrence, it’s time to accelerate your purchasing.
Above 50
Finally, when the VIX goes above 50, it’s time to go all in! The VIX has jumped to levels above 70 just once – during the lows of the 2008 and 2009 correction. If you were buying then, you would have made at least 4-5 times the initial investment.