If the stock market is so volatile, why would I want to put my money into it?

Question:   If the stock market is so volatile, why would I want to put my money into it?

In this question, volatility refers to the upward and downward movement of price. The more prices fluctuate, the more volatile the market is, and vice versa. Now, to answer this question, we must ask another one: is the stock market really volatile?

The answer is, "Yes, it is … sometimes." The market is volatile, but the degree of its volatility adjusts over time. Over the short term, stock prices tend not to climb in nice straight lines. A chart of day-to-day stock prices looks like a mountain range with plenty of peaks and valleys, formed by the daily highs and lows. However, over months and years, the mountain range flattens into more of a gradual slope. What this implies is that if you are planning to hold a stock for the long term (more than a few years), the market instantly becomes less volatile for you than for someone who is trading stocks on a daily basis.

And in some cases, short-term volatility is seen as a good thing, especially for active traders. The reason for this is that active traders look to profit from short term movements in the market and individual securites, the greater the movement or volatility the greater the potential for quick gains. Of course, there is the real possibility of the quick losses, but active traders are willing to take on this risk of loss to make quick gains.

A long-term investor, on the other hand, doesn't have to worry about this day-to-day volatility of the market. As long as the market continues to climb over time, as it has historically, your good investments will appreciate and you'll have nothing to worry about. Because of this long-term appreciation, many choose to invest in the stock market.


Read more: http://www.investopedia.com/ask/answers/03/070403.asp#ixzz2KBrWomXz

Volatility and the Stock Market

Is market volatility running high or is it running low (maybe too low)?

I've read several news articles just this week saying the market is increasingly volatile. I've also seen analyses expressing surprise that volatility hasn't jumped higher as the S&P has slid 7.2% from its September high.

The answer is that volatility-as measured by the CBOE Volatility Index (VIX)-is right now on the borderline between historical "high" and "low."

The VIX is based on S&P options, where option pricing reflects traders' volatility expectations. When options are expensive (relative to stock price, etc.), it means traders are betting on high volatility; when options are cheap, it means traders are betting on low stock volatility. The VIX index quantifies what volatility traders "must be" expecting.

Analysts generally use the VIX as a measure of investor sentiment. High VIX reflects high uncertainty. And because markets are usually more volatile when prices are falling, a high VIX can also suggest high expectations for falling prices.

A low VIX means low expected volatility, which is more associated with expectations of rising prices.

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What's high and what's low depends on the time span you consider. The 20-year chart below shows four alternating VIX eras; low from 1993 to 1996, then high from 1997 to 2003, then low again from 2003 to 2007, and back to high from 2007 on. The dividing line between high and low is in the area of .14 to .18. The VIX is currently at .16, right in that boundary zone.

Relative to the "high" VIX era that started in 2007 (ranging all the way from .14 to .80), current volatility is very low. Even setting aside that astonishing VIX spike up to .80 in late 2008 (the height of the financial crisis), current readings are at about one-third the levels posted in short bursts in 2010 and 2011.

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The second chart takes a closer look at the last three years. It shows four occasions when VIX dipped down to (and a little below) the current level.

The first low was in April 2010, followed by a sharp spike as the market corrected for three months. The second low was in April-May 2011, again followed by a VIX spike as the market corrected for five months. The third occasion was in March 2012, followed by a less dramatic VIX rise as the market corrected for two months. The final VIX low of these three years was in September 2012, and the market has pulled back for the two months since.

The VIX has been rising as the market retreated over these last two months. But it hasn't risen very much, and it's still in that borderline zone between high-eras and low-eras. For now (until proven otherwise), the presumption has to be that volatility is still low in a continuing high-VIX era, rather than (potentially) high in a new low-VIX era.

What does it all mean? Simply that additional market weakness is unlikely unless/until either (a) VIX spikes higher again, or (b) the market enters a new low-VIX era by sliding down below the boundary zone to about .14 to .16.

http://www.nasdaq.com/article/volatility-and-the-stock-market-cm191664#.URNAFB11_wM

The VIX Indicator: Beat the Crowds to Big Profits with the Ultimate "Fear Gauge"

The VIX Indicator:

Beat the Crowds to Big Profits with the Ultimate "Fear Gauge"


June 17th, 2010

Investors are motivated by two things and two things only: Fear and Greed. It's just that simple.

So more often than not, investors turn quite bullish when they think a stock is headed higher and quite bearish when they fear that all is lost. The trouble with this strategy is that during these extremes in sentiment they often lose their shirts.

While conventional financial theory suggests that markets behave rationally, not accounting for the emotional aspect of the trade often leads to the wrong entry and exit points.

And believe me when I tell you this: It's hard to turn a buck on the Street when you're constantly getting one or both of them wrong.

That's why successful traders often rely on the VIX indicator to assess whether or not the current market sentiment is excessively bullish or bearish... which helps them plot their next move.

You see, the VIX is a contrarian indicator. That is, it tells you whether or not the markets have reached an extreme position. If so, that tends to be a sure sign that the markets are about to stage reversal.

The idea here is that if the wide majority believes that one bet is such a sure thing, they pile on. But by the time that happens, the market is usually ready to turn the other way.

Of course, "the crowd" hardly ever gets its right.

It's counter-intuitive, but it's true nearly all of the time - especially in volatile markets.

And that's why the VIX indicator is a trader's best friend right now.

VIX, the Volatility Index Spikes Again

US stocks plummet, then recover some losses

US stocks plummet, then recover some losses
May 7, 2010 - 6:56AM

US stocks plunged 9 per cent in the last two hours of trading overnight before clawing back some of the losses as the escalating debt crisis in Europe stoked fears a new credit crunch was in the making.

The Dow suffered its biggest ever intraday point drop, which may have been caused by an erroneous trade entered by a person at a big Wall Street bank, multiple market sources said.

Indexes recovered some of their losses heading into the close but equities had erased much of their gains for the year to end down just over 3 percent, the biggest fall since April 2009.

"We did not know what a stock was worth today, and that is a serious problem," said Joe Saluzzi of Themis Trading in New Jersey.

Traders around the world were shaken from their beds and told to start trading amid the plunge as investors sought to stem losses in the rapid market sell-off.

Declining stocks outnumbered advancers on the New York Stock Exchange by more than 17 to 1. Volume soared to it highest level this year by far.

Nasdaq said it was investigating potentially erroneous transactions involving multiple securities executed between 2.40pm and 3pm New York time.

Investors had been on edge throughout the trading day after the European Central Bank did not discuss the outright purchase of European sovereign debt as some had hoped they would to calm markets, but gave verbal support instead to Greece's savings plan, disappointing some investors.

The Dow Jones industrial average dropped 347.80 points, or 3.20 per cent, to 10,520.32. The Standard & Poor's 500 Index fell 37.75 points, or 3.24 per cent, to 1128.15. The Nasdaq Composite Index lost 82.65 points, or 3.44 per cent, to 2319.64.

The sell-off was broad and deep with all 10 of the S&P 500 sectors falling 2 to 4 per cent. The financial sector was the worst hit with a fall of 4.1 per cent.

Selling hit some big cap stocks. Bank of America was the biggest percentage loser on the Dow, falling 7.1 per cent to $US16.28. All 30 component of the Dow closed lower.

An index known as Wall Street's fear gauge, the CBOE Volatility Index closed up more than 30 per cent at its highest close since May 2009. It had earlier risen as much as 50 per cent.

The mounting fears about a spreading debt crisis in Europe curbed the appetite for risk and put a report of weak US retail sales into sharper relief. Most top retail chains reported worse-than-expected same-store sales for April, sparking concerns about consumer spending, the main engine of the US economy.

That hit shares including warehouse club Costco Wholesale Corp, which fell 3.9 per cent to $US58.03, and apparel maker Gap Inc, which lost 7.2 per cent at $US22.91.

The head of the ECB, Jean-Claude Trichet, said on Thursday that Spain and Portugal were not in the same boat as Greece, but the risk premium that investors demand to hold Portuguese and Spanish government bonds flared to record highs.

Reuters


http://www.smh.com.au/business/markets/us-stocks-plummet-then-recover-some-losses-20100507-uh8l.html

The many flaws of Wall Street's latest rally

March 19, 2010

With US stocks pressing up against 17-month highs, the inevitable question arises: "Does this rally have legs?"

From one perspective, things couldn't look rosier for the bulls. The S&P 500 touched another 17-month high on Wednesday, breaking through levels analysts identified as significant resistance. More stocks in the S&P are hitting fresh 52-week highs than at any time during the course of the rally.

But the steady rise in the last six weeks has been accompanied by middling volume and underperformance in key areas, such as semiconductor companies. Market technicians and strategists believe the current run is overbought, suggesting at least a near-term pullback.

"What we are seeing represents a very defensive stance among investors," said Mike O'Rourke, chief market strategist at BTIG, an institutional brokerage firm in New York. "You are seeing investor disinterest in equities and that's why volume is languishing here."

This week's consolidated volume has been telling. With major averages hitting recovery highs, Monday marked the third slowest volume day of 2010 when about 7.24 billion shares traded on the combined New York, American and Nasdaq stock markets, below last year's estimated daily average of 9.65 billion.

The tepid volume suggests a lack of broader conviction, and is a sign momentum is mostly behind the latest run-up rather than any broad-based accumulation of stocks.(comment: an interesting point)

Momentum investing relies on chasing short-term price action on hard-charging stocks and shunning those that appear to be out of favor.

John Kosar, market technician and president of Asbury Research in Chicago, said there was a growing risk the run-up that resumed in February was a "countertrend" rally within a larger decline that began in January.

"Volume measures investor urgency and this recent lack of urgency to buy is characteristic of either peaking markets or countertrend rallies," he said.

Overbought
Investors were abuzz this week as the benchmark S&P 500 took out resistance at the 1150 level. Investors see that as clearing a path to a run to 1200. But other important technical metrics are not garnering the attention of the overall average.

According to Reuters chart data, the S&P 500's 14-day relative strength index (RSI), which measures the magnitude of the gains to determine overbought or oversold conditions, is hitting levels not seen since September 1995 - approaching 91, a threshold that technically signifies an overbought market.

An RSI ranges from zero to 100. When it approaches 70 that traditionally signals an overbought condition in an asset or an index, and the risk of a pullback increases.

Additionally, research firm Bespoke Investment Group pointed out that 89 per cent of S&P 500 stocks are trading above their 50-day moving averages, a level that usually augers for a pullback in the short-term.

Semi-tough
The semiconductor index has failed to confirm coincident 19-month closing highs in the Nasdaq Composite index, a bearish development considering technology's tendency to lead the market's advances and declines.

The S&P 500 is up 10.3 per cent since its recent closing low of February 8, while the small-cap benchmark Russell 2000 has rallied more than 16 per cent over the same period. Year-to-date the S&P 500 is up about 5 per cent, whereas the Russell 2000 is up 9 per cent.

To be sure, the run-up in small-cap stocks shows how risk appetite has risen due to optimism about the US recovery. Small-cap companies are viewed as more nimble and among the first to benefit from an apparent recovery.

But the divergence between strength in the Russell 2000 and the semiconductor index should be taken as a cautionary tale. Divergences occur when key indexes move in the opposite direction of the market's primary trend and tend to catch investors off guard.

Analysts say another ominous development is the sharp decline in overall volatility, suggesting complacency is setting in. The CBOE Volatility index, Wall Street's favorite gauge of investor sentiment, is trading at 22-month lows below the 17 level.

According to Kosar, declines to 18 or lower in the VIX have either coincided with or led every important near-term peak in the S&P 500 since October 2007. He said the market's gains may be limited without a near-term decline to work off extremes in investor complacency. VIX futures suggest a rise in volatility later this year.

"Although the February rally in US equity prices may continue from here on a week-to-week basis, a sustainable advance is unlikely from here without at least one to several months of a corrective decline first," said Kosar.

http://www.businessday.com.au/business/markets/the-many-flaws-of-wall-streets-latest-rally-20100319-qkf3.html

Why Now's the Time to Get Defensive

Why Now's the Time to Get Defensive
By Todd Wenning
January 13, 2010

Do you hear that?

 

To steal a phrase from Simon and Garfunkel, it's the sound of silence in the market. And it's making me nervous.

 

Remember just 12 months ago, when the CBOE Volatility Index, the "VIX," was comfortably over 40, implying significant investor uncertainty? Those were indeed scary times, a few months after Lehman Brothers collapsed in September 2008, but as an investor I was actually more comfortable then than I am right now. There were a lot of great stocks on sale!

 

You haven't heard about the "VIX" for a while now because, guess what, it's back below 20 -- implying investor complacency. We haven't been this low since (gulp!) August 2008, before the Lehman Brothers debacle.

 

Scared yet?
Even though the stock market has charted a steady upward course since last March, I have a hard time believing that all is well enough in the global economy to justify complacency.

 

That's why now is the time to get defensive. That means:

 

• Having cash available to invest.
• Considering options strategies to protect your gains.
• Building a watch list of stocks you'd want to buy at 10%-15% below current prices.

Traditional defensive maneuvers would typically include increasing your bond exposure, though with yields so low and interest rates inching higher, I don't think this is a great place to put new money right now.

 

My best friends call me "Cash"
Thanks to the government's policy of low interest rates and quantitative easing, there's been (by design) little reason to hold a lot of cash. That's helped fuel both the bond and stock markets, as investors looking for even a tiny profit needed to put their cash to work somewhere.

 

Still, cash isn't trash and there's simply no substitute for quickly seizing opportunities in the market. If you're 100% invested and the market loses value, you need to sell something (at a lower price, of course) before you can buy anything else. That's a tough position to be in when stock values become much more attractive.

 

In our Motley Fool Pro portfolio, for instance, we took advantage of last year's market downturn by using our cash to pick up solid companies like Intel (Nasdaq: INTC) and Autodesk (Nasdaq: ADSK) at very attractive prices. Today, we've strategically left a large cash balance in the portfolio to grab future bargains the market may throw our way.

 

Yes, you have options
Market volatility plays a major role in the pricing of options (calls and puts). This is because investors perceive "risk" as volatility and when volatility is low there's simply less demand from options buyers (who have the right to buy and sell a stock) who seek to improve returns with big moves in stock prices.

 

All of this is to say that when options prices are low and the market's been rallying, consider protective puts on stocks and exchange-traded funds that have made you big money.

 

Let's say you bought 100 shares of SPDR Gold Trust (GLD) ETF in November 2008 for $75 -- a $7,500 investment. The ETF currently trades for about $113 -- a nice 50% gain for you. By purchasing a March $110 put for $2.75, you can lock in a sales price of $110 for your 100 shares through March 19, 2010, for $275 per contract.

 

One scenario: The ETF doesn't fall below $110 by March 19 and you're out $275 (4% of your original investment). But hey, you can still enjoy any upside left in the ETF. The other scenario: The ETF falls well below $110, but you can still sell for $110 (minus the $2.75 per-share cost) thanks to the protective put you bought.

 

Think of buying protective puts on your big winners as insurance against the chance of losing those gains in a market downturn. Even though you may grumble when you pay the premium for the put, just as with your auto insurance, you'll be glad you did if something bad happens. At the very least, it can give you some peace of mind in an uncertain market.

 

Make a list, check it twice
U.S. stocks have made a huge recovery from their March 2009 lows, and while I don't think they're anywhere near bubble territory, good values have become harder to find. That doesn't mean you should stop researching, though.

 

Here are five S&P 500 stocks with returns on equity over 15%, price-to-free cash flow ratios below 20, and manageable debt levels -- in other words, strong companies worth buying if the market does take a downturn.

 

Company
Price-to-FCF
Return on Equity
Total Debt to Equity

 

Coach (NYSE: COH)
15.9
38.7%
1.37%

 

Gilead Sciences (Nasdaq: GILD)
16.0
49.4%
24.40%

 

Cisco Systems (Nasdaq: CSCO)
18.0
15.2%
25.70%

 

Stryker (NYSE: SYK)
18.3
17.7%
0.30%

 

Automatic Data Processing (NYSE: ADP)
17.1
25.4%
0.70%

 

 

Data provided by Capital IQ, as of Jan. 12, 2010.

 

 

Great companies don't always make great investments -- they still need to be bought at the right price.

 

Cisco Systems, for instance, has doubled its net income over the past decade, but remains 50% off its January 2000 prices. That's because investors were paying too dearly for Cisco's prospects during the dot-com bubble and, even though Cisco is a much better company today than it was in 2000, its 10-year stock chart doesn't reflect this progress.

 

That's why it's so critical to buy great companies only at the right prices. Another market dip could give us that opportunity, so prepare yourself now with a good watch list.

 

Get started now
When the market grows complacent, you need to get defensive -- no matter where you think it's going. It's only a matter of time before something spooks the herd and volatility once again ensues. By having adequate cash on hand to buy solid stocks at good prices and using options strategies to protect your gains, you can set yourself up for better long-term investment success.

 

That's our aim at Motley Fool Pro, where we use stocks, ETFs, and options to help investors make money in all types of markets. If you'd like to learn more about Pro, simply enter your email address in the box below.

 

http://www.fool.com/investing/general/2010/01/13/why-nows-the-time-to-get-defensive.aspx

How high is high and how low is low.

Buying when the VIX is high and selling when it is low have proved profitable in recent years. However, so has buying during market spills and selling during market peaks.

The real question is how high is high and how low is low.

For instance, an investor may have been tempted to buy into the market on Friday, October 16, 1987, when the VIX reached 40. Yet such a purchase would have proved disastrous given the record 1-day collapse that followed on Monday.

VIX: Volatility Index

In 1993, the Chicago Board Options Exchange (CBOE) introduced a volatility index, called VIX, based on actual index option prices and calculated this index back to the mid-1980s.

In the short run, there is a strong negative correlation between the VIX and the LEVEL of the market. When the market is falling, the VIX rises because investors are willing to pay more for downside protection. When the market is rising, the VIX typically goes down because investors become less willing to insure their portfolios against a loss.

When anxiety in the market is high, the VIX is high, and when complacency rules, the VIX is low. The peaks in the VIX corresponded to periods of extreme uncertainty and sharply lower stock prices.

In the early and middle 1990s, the VIX sank to between 10 and 20. With the onset of the Asian crises in 1997, however, the VIX moved up to a range of 20 to 30. Spikes between 50 and 60 in the VIX occurred on 3 occasions:

• when the Dow fell 550 points during the attack on the Hong Kong dollar in October 1987,
• in August 1998 when Long Term Capital Management needed to be bailed out, and,
• in the week following the terrorist attacks of September 11, 2001.

All these spikes in the VIX were excellent buying opportunities for investors. Peaks in the VIX also correspond to periods of extreme pessimism on the part of the investors. On the other hand, low levels of the VIX often reflect too much investor complacency.

VIX Index

Volatility Index (VIX)

What it Is:

The Volatility Index (VIX) is a contrarian sentiment indicator that helps to determine when there is too much optimism or fear in the market. When sentiment reaches one extreme or the other, the market typically reverses course.

How it Works:

The VIX is based on data collected by the CBOE, or Chicago Board Options Exchange. Each day the CBOE calculates a figure for a "synthetic option" based on prices paid for puts and calls. The computation of the VIX was changed in 2003 and is based on the S&P 500 option series.

The key question the Volatility Index answers is "What is the 'implied,' or expected, volatility of the synthetic option on which the index is based?" We already know the following variables:
-- The market price of the S&P 500
-- The prevailing interest rate
-- The number of days to expiration of the option series
-- The strike prices of those options contracts

What the equation solves is the "implied," or expected, volatility.

What is volatility?

One definition describes volatility as "the rate and magnitude of changes in price." In simple English, volatility is how fast prices move.

When the market is calm and moving in a trading range or even has a mild upside bias, volatility is typically low. On these kinds of days, call option buying (a bet that the market will move higher) generally outnumbers put option buying (a bet that the market will go down). This kind of market typically reflects complacency, or a lack of fear.

Conversely, when the market sells off strongly, anxiety among investors tends to rise. Traders rush to buy puts, which in turn pushes the price of these options higher. This increased amount investors are willing to pay for put options shows up in higher readings on the VIX. High readings typically represent a fearful marketplace. Paradoxically, an oversold market that is filled with fear is apt to turn and head higher.

Why it Matters:

The Volatility Index works well in conjunction with other "overall market indicators." By studying its message, traders will have a better understanding of investor sentiment, and thus possible reversals in the market.

http://www.streetauthority.com/terms/v/vix2.asp


VIX values greater than 30 are generally associated with a large amount of volatility as a result of investor fear or uncertainty, while values below 20 generally correspond to less stressful, even complacent, times in the markets.

The index is often referred to as the "investor fear gauge".