Complacency Indicator

 

If you haven't heard of the technical indicator with the stock market symbol VIX it is now time to pay some attention to it. When the number is running low, as it is now, around 15 to 18 it means everyone is happy and thinks the stock market is going to continue up or at least continue on its current path and there is no need to sell anything. This is a measure of complacency. When the number goes above 35 it means everyone is very nervous and thinks the market is going to fall. It is considered a contrarian indicator.

Wall Street calls this the Volatility Index which disguises its real underlying meaning. What it really should be called is the FEAR and GREED Index.

The average investor buys with a greed motive when the VIX is low and sells only after fear sets in when the number is high because he is afraid of further loss. These are emotional moments and the market is an emotional animal. The truly smart investor has a planned exit strategy before he buys anything; he knows when to sell even before he buys.

Notice that the higher and smoother the movement of the market the more complacent the investors become. The investor becomes overconfident that his stocks will always go up. It is a truism that investors buy with only thoughts of how much they will make and never consider that it is possible to lose. When I was a broker and a member of the exchange I would only keep customers who would place stop-loss orders as soon as they bought something. I always stressed protection of capital.

When you are a serious and reasoning investor you must always think about loss first. If what you buy goes up you don't have to worry. Winning takes care of itself. Losses don't.

As of March 26, 2004 the VIX can now be traded like a stock. If the VIX is currently 18.5 the value of the contract is $18,500 and trades in $10 increments. It can be very volatile; a move from 18 to 38 can make (or lose if you are short) $20,000. This is not for the feint of heart and should be left to the professional speculators.

When you look at the historical charts and run a comparison of both the VIX and the S&P500 Index you will see the inverse correlation. As the S&P goes up the VIX goes down and visa versa.

There are many technical indicators that are used to determine market direction and this is just one of the many. It can be part of your analysis if you are a technician along with moving averages, various ratios and other stratagems.

Whatever you do do NOT become complacent about the money you have invested in your 401K or any other stock market investment. Protection of your capital is always your first consideration.

Copyright 2005

 



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