The VIX (Chicago Board Options Exchange Market Volatility Index) was designed to determine the quantity of fear amongst investors. A VIX number that is
increasing is a sign that there is a market in which investors are in a mode of ‘fear.’ In many instances, an increase in volatility will lead to a
market sell-off, whereby a decrease in volatile will lead to normalized situations. Most investors dislike spans of increased volatility, whereas most
traders enjoy the increased volatility. It’s because with the increased volatility, they easily can exit and enter positions, and make big profits
VIX 1-yr chart
In the above chart, it’s clear that the volatility level currently is within the highest periods this year. It has been fueled by fears that the economy in China is shrinking. Last August, the government in China devalued their currency in order to make their exports more competitive within the market. Additionally, the government reported that their economy was increasing slower than expected. It led to a global market sell-off along with all industries feeling the impact. As a consequence, the quantity of volatility in the global financial market rose as investors took a careful approach because a dip in Chinese growth is a threat to the global economy.
Before this, the VIX, last April, May and June, recorded higher levels at the peak of the Greece crisis. Also, it’s expected that the index is going to grow after the interest rate determination by the federal open market commission recently.
Observing the VIX
As a day trader, you ought to make it a habit to have the VIX index always on your screen. It ought to be the first screen you check any time before beginning trading. Doing so will assist you in understanding the market and additionally offer a forecast of what you can expect. You must compare the trend within the VIX along with the price action of the main instruments like the dollar index and the index future contracts. In comparing convergence-divergence associations between the VIX and those instruments, it’s a sign of what the market is going to look like within the trading session.
By checking the charts prior to a trading session, numerous things may be made. First, a rise in the NASDAQ, S&P 500 and VIX will signify a bearish trend, presenting an excellent chance to short the market. Second, a rise in the VIX, a dip in S&P 500 as well as NASDAQ index futures will signify a bearish convergence. Thirdly, a rising NASDAQ, failing VIX, and rising S&P will indicate a bullish trend for that day. Thereby, by looking at the VIX and then comparing it with the key instruments and indices, you’ll be at a great position to make exceptional decisions within your trading day.
Avoid key asset classes
Market volatility is caused by a variety of macro factors like a dip in GDP of key countries like China. To remain safe within this time, it’s critical that you stay away from key assets which have exposure to the said market. For example, within the Greece crisis, numerous asset classes had direct exposure toward the market. The EUR included the first culprit that traders should’ve avoided. In the recent crisis in China, traders who went along with companies which depend upon the Chinese market made substantial losses. There will include several instruments which investors may purchase to protect their portfolios.
Utilize the Chinese market
5-yr. chart for: VIX, Shanghai composite index as well NASDAQ and S&P 500 composite
China includes the most substantial market in the financial market of today. Their markets close and open hours before the U.S. markets open. On many days, what occurs in the Chinese market will have a direct correlation with what occurs when the U.S. market opens. For example, if the Chinese stocks significantly fall, it’s always expected that the NASDAQ, S&P 500, and DOW will fall. Thereby, as a trader, you always can go short if the 3 Asian markets fall and then vice versa.
Utilize the options market
Options market includes an appealing method of trading a volatile market. A way to do this includes buying puts for companies you know very well or own. It’ll assist you in protecting your money in the instance of a downside. Utilizing options, you also can initiate a straddle particularly as you expect the market to aggressively go down or up.
In the financial world, market volatility always will be there. Market volatility is a day trader’s friend. It’s within a volatile market that you have the ability to double or even triple investment capital. By considering the above strategies, you’ll be able to anticipate the market then place good trades. It doesn’t caution you from making losses, yet it’ll protect you from your bank account becoming wiped away.