The “Fear Index” is at an all-time low! But wait, is that a good thing?

What's the "FEAR INDEX"?

Investor confidence has long been regarded as a key factor in stock market price movements. When investors are confident they are more likely to invest their money; when they’re afraid of unforeseen volatility they tend to withdraw their money from investments and wait for safer opportunities.

But how do you measure this elusive factor? Many investors and analysts rely on the “Fear Index” to tell them how confident investors are at any given moment.

What is the Fear Index?

In 1993, the Chicago Board Options Exchange launched the VIX, an index that measures the perceived volatility of the markets, which analysts quickly came to call the “Fear Index”. The index relies on the perceived volatility of S&P500 index options to indicate the general uncertainty of the market, i.e. how risky the market seems to investors.

The Fear Index doesn’t predict whether the markets will go up or down, all it does is calculate the variance in swap rates within a 30 day period to give an estimate of market stability.

When the Fear Index is high

A high Fear Index does not necessarily predict a Bearish market, although it does coincide with major market crises and crashes, such as the 2007 financial crisis and its aftermath. All it means is that the market is volatile in either direction, which means that the index can be high when the markets are skyrocketing as well as plummeting.

In either case, investors that are averse to risk won’t want to enter the market when the VIX is too high, even in a bullish period because they are afraid of a sudden trend reversal. Investors who don’t mind high risk situations however don’t want a low VIX index, because it means less opportunities for quick returns.

When the Fear Index is low

Right now the VIX is at the lowest point its ever been since the crisis (with slight upswings caused by the recent Malaysian Airlines catastrophe in the Ukraine and unrest in the Middle East), while the “original” VIX, which is based on S&P100 options instead of S&P500, hit an all-time low at the beginning of July.

While this is a good sign of a stabilizing economy, investors and traders are not exactly celebrating. Low volatility may mean safer investments, but when things are this quiet it’s hard to make profits, especially if you’re a short term trader.

However, many analysts are predicting an impending upswing for the VIX, based on both recent world events and on technical considerations. When the markets slow down to a near standstill, many investors start to get antsy and to restructure their portfolios (sometimes out of sheer boredom!) thus causing volatility to return.

Article Written By: Abby Tsype