How to Use the VIX, VXN, and VXD to Gauge Market Volatility - dummies

How to Use the VIX, VXN, and VXD to Gauge Market Volatility

Market volatility is the day trader’s best friend, because it creates increased opportunities to profit from day trading. The volatility of a stock, bond, or commodity is a measure of how much that security tends to go up or down in a given time period. The more volatile the security, the more the price fluctuates. Three handy measures of market volatility are the VIX, the VXN, and the VXD.

VIX is short for the Chicago Board Options Exchange Volatility Index. Calculating VIX is complex enough to border on being proprietary, but it is available on many quotation systems and on the exchange’s website.

The VIX is based on the implied volatility of options on stocks included in the S&P 500 Index. In addition to the VIX, the exchange also tracks the VXN (volatility on the NASDAQ 100 Index) and the VXD (volatility on the Dow Jones Industrial Average.)

The greater the volatility, the more uncertainty investors have; the more options that show great volatility, the more widespread is the concern about prospects for the financial markets.

In fact, the VIX is often called “the fear index” and is used to gauge the amount of negative sentiment investors have. The greater the VIX, the more bearish the outlook for the market in general. The more bearish the outlook, the more likely the market is volatile.

Traders can use the VIX to help them value options and futures on the market indexes. (For that matter, traders who want to take a position on market volatility can use options and futures contracts on the VIX, including a mini-sized future, offered by the Chicago Board Options Exchange.)

The VIX can also be used to help confirm bullish or bearish sentiment that shows up in other market signals, such as the tick or the on-balance volume measures described earlier. The CBOE also calculates a VIX number on a handful of common stocks, if you are trading those issues or the options on them.