The aftershocks from the recent day trader rampage are receding now, but the CBOE Volatility Index or “VIX” remains a little elevated from what I consider comfortable levels.
In fact, the VIX hasn’t traded in normal statistical territory since Feb. 24, 2020, when COVID-19 cases started to bloom across the United States and the pre-pandemic world began shutting down.
It made sense. This is often called the “fear” index, and when everyone is facing an unknown and lethal disease, fear is the natural response.
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But the GameStop Corp. (NYSE:GME) storm wasn’t about fear at all. While the hedge fund community shifted to a more defensive posture overall, the big market moves we saw in the last few weeks were really all about greed.
Day traders smelled an easy win. The stocks they gravitated toward started to swing so widely that they moved the index funds that contained them.
As those index funds gyrated, the VIX jumped to 37. I usually consider any reading above 16 to be elevated and anything above 20 qualifies as a bona fide volatility spike.
That’s the first point I want to make today. The VIX measures greed as well as fear, bull market heat as well as the bearish chill that follows.
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When the VIX rises, we know the weather is going to change. But it doesn’t always tell us which direction stock prices will go.
Of course, math implies that a change in direction is usually negative. The market spends most of its time in an upward trajectory, testing and then breaking records season after season.
When Wall Street follows that trend, surprises are relatively rare. Professional investors expect to make money. Stocks usually go up.
If that doesn’t capture your mindset, you might want to consider a different investment style, one that’s geared toward preserving your wealth and squeezing income out of what you already have.
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That’s what we do in my Value Authority portfolio. We’re not about building a fortune there. All we want is to keep up with the market and receive reasonable amounts of cash flow in the form of dividends.
Those stocks naturally thrive in a low-volatility environment and they’re exceptionally defensive when the VIX rises.
My point here, however, is that when stocks are in favor, the only way they can realistically shift direction is to speed up their rally or, more likely, take a step back. Most VIX spikes reflect a step back. This is when you see sudden market corrections. When the default mood is biased toward greed, it takes an infusion of fear to bend the trend.
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And sometimes the pendulum of sentiment swings too far. When fear builds up, a strong burst of relief can drive the VIX up as well.
We’ve seen this play out after every significant market downswing in history. The initial VIX spike is all about panic, but then relief takes over and keeps ambient volatility well above normal levels.
You know the psychology. The initial shock triggers instinctive response. Usually that’s a sell signal unless you have a lot of nerve.
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But when the instinct fades, we realize the world didn’t actually end. We’re still alive, the economy is functioning and some stocks are worth more than others in the long term.
That’s relief. Stocks that plunged now soar. The VIX remains elevated.
I wouldn’t want the market to behave any other way. Look at the past year. The pandemic was an enormous shock to everyone’s system.
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The number of people who have died worldwide during the pandemic reached 2,293,416, including 458,037 in America alone, as of Feb. 5, according to Johns Hopkins University. And the pandemic is far from finished. The disease has left enormous damage behind. But the survivors found ways to cope.
Life goes on. And the companies that find ways to thrive in the new environment can make shareholders a lot of money. That’s when more optimistic strategies like my GameChangers take over.
What are you afraid of, right now? The election is over. The vaccines are coming. The economy is healing. The Fed remains alert.
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We might not like the results or the execution, but every day takes us farther from the big uncertainties that sometimes felt like they were going to swallow the market last year.
After the 2008 crash, the VIX didn’t get back to “normal” until 2010. It took 18 months for the psychic trauma to fade.
That’s the kind of sentimental environment we’re in now. Relief needs time to work.
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But until it does, volatility is our friend. 2-Day Trader subscribers are making money on short-term options, month after month.
As long as investors stick to our system, they’re able to turn whipsaw markets into strong gains, no matter whether the rollercoaster is pointed up or down on any given day.
I’m talking about all of this on my Millionaire Makers radio show. Now there’s a podcast (Spotify)(Apple) as well to keep you focused on opportunities to build real wealth while avoiding obvious threats.