The Volatility Index (VIX) is used by traders as an indication of whether the market is going to rise or fall within the next 30 days. Active investors look to the VIX because it tells them if traders are feeling bullish or bearish. When the VIX is at very low levels, such as is currently the case, it indicates that average investors are feeling optimistic and everyone is getting on the bandwagon to enter the market because they are convinced it will keep going up. This perception is evidenced by the recent exodus from bonds into equities. However, in the eyes of sophisticated money managers and savvy traders a low volatility index is actually highly concerning and reason for caution. The professional traders prefer when there is pessimism in the market. Historically, the market climbs up a wall of worries and when it is downright bearish then there is a tendency to have even explosive days in the market. When the VIX is at a high level savvy traders believe that there is a greater probability of the market moving up.
The numbers suggest, in general, that there is an inverse relationship between volatility and market direction. Presently, the VIX is at 17.31 as of Friday January 7, 2011. SPY, the highest volume trading ETF which replicates S&P 500, closed at $127.14. This is in direct contrast to numbers at the beginning of June 2010, just before the most recent bull-run, when the VIX was hovering around at 36 and SPY was trading at approximately $105. This marks a 20% increase in the value of SPY during a 6 month period. The market needs to have a correction in order to climb a wall of worry again.