What Is the Volatility Index and Why It’s Important for Traders

Volatility is the measure of how much the price of a given asset fluctuates from one trading day to the next. In other words, it’s a measure of how much fear or uncertainty is in the market. A highly volatile asset will see wide swings in its value from day to day, whereas a less volatile one will see much smaller daily moves.

Because volatility is such an important concept for traders, we’ll explore it in-depth in this article. You’ll learn what the volatility index is, its historical volatility, how to measure it, and examples of assets that exhibit high and low volatility. Read on to learn more.

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The Volatility Index (also known as the VIX) is one of the most widely-followed measures of investor anxiety. It’s also one of the most commonly-used tools in the world of trading. And for good reason: It can be very useful for an aspiring trader, especially if they’re just getting started. (We know we were!)

What is the Volatility Index?

The Volatility Index (VIX) is a barometer of investor sentiment that was developed by Fidelity Investments in 1992. Rather than using financial indicators like the S&P 500 or Dow Jones Industrial Average, Fidelity looks at how the prices of different assets have reacted to recent news.

For example, consider an asset that has seen its fair share of volatility lately. If a stock goes from $100 to $50 in a day, that’s obviously going to move the VIX up a lot. But what if the move from $50 to $100 isn’t that big? The VIX would give less significance to that move and may even put it in the “no big deal” category.

What is the Historical Volatility of an Asset?

As we mentioned above, one of the key metrics the VIX uses is to track how volatile a given asset is. But how do you determine how volatile an asset is in the first place? There are a few ways to go about doing this.

One easy way is to look back over a historical period. Let’s say you want to find out how volatile gas prices are. You could pull up Google and type in some key words like “gas historical volatility” or “gas historical data” and sure enough, you’ll get a table of data dating back as far as you want.

Another way is to use options. Options give us a way to express how much volatility we’d like an asset to have over a given period of time. The more volatile we believe an asset should be, the deeper the call and put options we purchase.

How to Calculate the Volatility Index

To determine the historical volatility of an asset, start by finding the daily percentage change in price for a given period of time (usually one day). Once you have those figures, subtract the average daily change from that amount. The result is the amount of volatility for that particular period.

Let’s use the gas example from above. If the price of gas went from $3 to $4 one day and $2 the next, then the volatility for that period is ($4 – $2 = $2). If we take the daily change of $4 and subtract the average daily change of $2, we get a total of $2 for that period of time.

How to Interpret the Volatility Index

The VIX is a number between 0 and 100. The higher the number, the more volatile the stock market is perceived to be.

What does that mean, though? The most common way to interpret the VIX is to say that a stock with a low VIX is considered “safe” while a stock with a high VIX is seen as “risky.”

There are a few problems with this, though. For one, it assumes that the VIX is a good indicator of how stocks will perform in the future. But stocks don’t move in a straight line and there are plenty of exceptions to this rule.

Furthermore, the VIX is a single number that doesn’t capture all the factors that could be causing someone’s asset to be more or less volatile. For example, there’s the question of whether the low or high VIX asset is actually cheaper.

Examples of High and Low Volatility Stocks

Now that you know what the volatility index is and how to calculate it, let’s look at some real-life examples.

The S&P 500 has an average volatility of around 11%. That means that on any given day, the price of the S&P 500 is 11% less likely to be exactly where you think it is than at the moment.

Now, consider the bitcoin SV chart. As of this writing, Bitcoin SV has seen six different successful coin tosses (and they’ve all been extremely bullish). At the same time, the VIX for bitcoin is just 1.6.

That means bitcoin has been a lot more volatile than the S&P 500 and a lot less volatile than Fidelity expects. Put simply, based on the historical data we have for bitcoin, it’s likely to keep going up.

Final Words: Is the VIX Right for You?

The short answer to this question is yes, but only to a certain extent. While the VIX is a useful tool for analyzing asset volatility, it doesn’t tell the whole story.

For example, consider the fact that the VIX is based on how stocks are performing now, not how they’ll perform in the future. After all, there are plenty of historical data points that support the fact that the future is unknown.

If you want to trade stocks that exhibit high volatility, you want to make sure you’re comfortable with the amount of risk involved and that you’re comfortable with the potential reward.

If you’re looking for a more casual way to follow asset volatility, check out our volatility tracking service. It’ll let you keep tabs on the most volatile assets in the world 24/7 and give you a much better idea of where to get involved.

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