Since the start of 2018, the US stock market has had some incredibly wild swings. Stocks started the year with a bang, with the S&P 500 only seeing four negative trading days for the entire month of January.
February was the month that changed everything, however. Upon fears of inflation getting out of hand, and the Federal Reserve possibly hiking interest rates more than expected for 2018, stocks sold off sharply. The S&P 500 declined more than 300 points, or approximately 10.70%, in just three days!
Unequivocally, investors from around the world panicked and dumped large portions of their long stock portfolios. Volatility, commonly referred to as “investor fear”, which is measured by the CBOE VIX Index, shot up to 50.30, a level not seen since 2014.
High Volatility Causes Wild Price Swings
The VIX Index measures implied volatility of options contracts on the S&P 500, and in general, the higher the VIX index is, the higher the level of investor uncertainty. When there is more fear and uncertainty in the market, investors are willing to pay a higher premium to protect their stock positions. What does this mean for the average buy-and-hold investor?
Well, when volatility is high, investors should take note and brace for impact. High volatility means stocks can either move up or down significantly in a very short period of time; this is a very important concept to understand. Although it’s not the most comforting thing to hear, high volatility will almost certainly result in large gains or losses in one’s personal stock portfolio.
What separates armature investors from the professionals is the actions they take during the increased periods of volatility.
More times than not, unfortunately, high volatility equates to large losses for long stock investors. Since the inception of the stock market, investors always seem to be more fearful of a downwards market “crash” than an upwards one. This is why stocks can easily selloff by 10% in a few days, but it would be exceedingly rare for stocks to trade up 10% in a few days without plummeting first.
When stocks begin to crash down, investors simply want to get out and prevent any further losses, and this creates a snowballing effect that only exacerbates the selloff.
High Volatility Creates Opportunity
Heightened volatility is not entirely sour news. Many investors, like Warren Buffet, look to increase their holdings when prices become discounted. Since high volatility tends to create wild and dramatic price swings in stocks, savvy investors can look to buy stocks at a discount amid the market chaos. Of course, it’s nearly impossible to time the markets, but using the VIX Index as an indicator to determine when markets are acting irrationally certainly has some merit as an investment strategy.
Had investors bought the S&P 500 after the 10% selloff in February of this year, when the VIX Index was at its peak near 50.30, they could have locked in a high single-digit percentage gain in only a few weeks, as prices began to recover and the VIX Index reverted to its “average” price of around 20.
During periods of low volatility, the S&P 500 has virtually never increased in price by more than 5% in only a few days. Dramatic moves like this only happen when volatility is high. Therefore, when volatility is high, it behooves investors to tune in to the markets and analyze their positions to see if there is a potential timely investment opportunity.
Post by Options Bro www.optionsbro.com
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