What's market volatility and the VIX?
If there’s one thing investors know for sure about financial markets, it’s that they’re unpredictable. This means that market volatility is unavoidable, and the first step towards better dealing with volatility is to understand what it is and how it can affect your portfolio. Here’s what you need to know.
Volatility and the VIX explained
In an investing context, volatility is the frequency and magnitude of price movements in the stock market—or, more specifically, a market index. While most investors probably associate volatility with painful market declines, in reality, it’s a two-sided coin, as it’s a function of price gains as well. The more dramatic the market’s price swings are—whether those swings are market increases or decreases—the higher the level of volatility. Price changes occurring within the span of a trading day reflect what’s known as intraday volatility.
The most frequently used volatility benchmark is the Cboe Volatility Index—commonly known as the VIX and often referred to as the market’s fear index, or fear gauge. It’s a barometer of investors’ expectations for market uncertainty over the next 30 days—that is, it’s a forward-looking indicator of expectations for market volatility. It’s measured by fluctuations in prices for options on the S&P 500 Index. (Options are contracts offering the buyer the opportunity to buy or sell stock—depending on whether the contract is a call option or a put option—at a stated price within a specific timeframe.)
When investors expect more uncertainty in the near future, they bid up the prices of options, so the VIX rises. On the other hand, if they expect calmer markets, option prices fall, causing the VIX to decline. Typically, a decline in stock prices is accompanied by a rise in the VIX, especially when price declines are more pronounced.
What’s high for the VIX? What’s low?
From January 1990 through March 2022, the VIX’s average closing price was 19.5. The index does occasionally descend into the single digits, as it did through an unusually quiet stretch for stocks in 2017.
A picture of market volatility
Cboe Volatility Index (VIX), January 1990–March 2022
Source: Manulife Investment Management, Macrobond, as of March 4, 2022
During the global financial crisis, the VIX spiked to a record high of 89.5 in intraday trading on October 24, 2008. The record closing high, however, was seen on March 16, 2020, at the height of the COVID-19 pandemic; on that day, the S&P 500 lost 11.98%.
What volatility and the VIX may mean for investors
The first thing to note is that the VIX is an index, so just like any other index, it’s not directly tradeable. There are products such as exchange-traded funds that can be used to trade the VIX, as well as tradeable options and futures on the VIX (for more sophisticated investors), but unless you hold one of these products, movements in the VIX wouldn’t directly affect your portfolio.
However, the way that the VIX can affect your portfolio is psychologically. Thanks to its reputation as a fear gauge, when the VIX rises, investors—seeing that others in the market are expecting volatility and uncertainty—may be prompted to panic sell, which could affect long-run performance of individual portfolios. Any period of heightened uncertainty can be an opportune time to meet with a trusted financial professional to review your financial goals and follow a plan that helps you make the most of what may continue to be a challenging situation.
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