Investors are motivated by two things and two things only: fear and greed.
It's just that simple.
That said, more often than not, they turn quite bullish when they think a stock is headed higher — and quite bearish when they fear that all is lost.
The trouble with this strategy is that, for most investors, it is precisely at these extremes in sentiment when they often lose their shirts...
Conventional financial theory suggests that market behaves naturally.
That said, investors often don't account for the emotional aspects of the trade. This leads to the wrong points of exit and entry. When the market is dipping, the bulk of investors panic and sell.
More than likely, if you have dabbled in investing, you are aware of this. When the market is dipping many investors sell.
On the flip side of that same coin, those same investors often buy back in at the top. They don't feel confident until the stock has reached a strong point, which often means it's preparing for another dip. It's a profit-losing cycle.
And believe me when I tell you this: It's hard to turn a buck on Wall Street when you are constantly buying at the top and selling at the bottom.
To maximize profits, you have to go against the conventional.
And top analysts know it. That’s why they rely on the VIX Index to assess whether or not the current market sentiment is either excessively bullish or bearish in order to plot their next move.
It turns out that all you need is the use of a valuable tool to turn a negative experience will Wall Street into a watershed of profits.
Make Better Trades Using the Fear Gauge
Once upon a time, a london hedge fund used Twitter to turn quite a profit.
The idea behind the hedge fund was simple: If the mood on Twitter was negative, the hedge fund would sell. If the mood was optimistic and positive, they would buy.
Using this method, the fund was able to predict the market with 86.7% accuracy.
Today that hedge fund is no longer in existence. Not because it didn't work, but because it relies on a less proven method than the VIX.
But the underlying investment principle is the same: emotions control the market.
If Twitter was closing on a positive note, there would likely be buying on the market the following day. If the overall public opinion was negative, there would likely be selling.
The VIX helps investors capitalize and manage an emotional market in a different way.
You see, the VIX Index is one of the so-called contrarian indicators.
That is, it tells you whether or not the markets have reached an extreme position one way or the other. If so, this tends to be a sure sign that the markets are about to stage a reversal.
The idea here is that if the wide majority believes one bet is such a sure thing, they pile on. But by the time that happens, the market is usually ready to turn the other way.
Of course, as we pointed out above, "the crowd" hardly ever gets it right (so much for the rational market theory)...
So the smart money simply uses the VIX Indicator as a sign to bet against them all.
If "the crowd" is feeling very bullish, in other words, it is definitely time to think about getting bearish.
It's counter-intuitive for sure, but it works 99% of the time — especially in volatile markets.
And that's why the VIX indicator is a trader's best friend these days... because if there is one way to describe today's markets, it would have to 'volatile.'
So, what is the VIX Index?
Developed by the Chicago Board Options Exchange in 1993, the CBOE Volatility Index (Chicago Options: ^VIX) is one of the Street's most widely accepted methods to gauge stock market volatility.
It was constructed using the implied volatilities of a wide range of S&P 500 index options. Since 2004, it has become a far more expansive and valuable tool using information from the entire S&P 500.
But because it is basically a derivative of a derivative, it acts more like a market thermometer more than anything else.
And like a thermometer, there are specific numbers that tell the market's story...
A level below 20 is generally considered to be bearish, indicating that investors have become overly complacent.
Meanwhile, with a reading of greater than 30, a high level of investor fear is implied, which is bullish from a contrarian point of view.
The smart thing to do then is to wait for peaks in the VIX above 30 and let the VIX start to decline before placing your buy...
As the volatility declines, stocks, in general, will rise and you can make big profits.
You see it time and time again. In fact, the old saying with the VIX is: "When the VIX is high, it's time to buy."
That's because when volatility is high and rising, "the crowd" is fearful. And when "the crowd" is fearful, they sell — and stock prices fall dramatically, leaving bargains for moneymaking traders.
Basically, you can think of the VIX as your sales alert tool.
You can tell when the markets are going to drop. And, with this knowledge, you will be able to scoop up certain stocks at a "discounted price."
When these stocks boom, you will know that you are one of the smart investors who bought at the bottom and watched their investment rise alongside of market confidence.
Investors who feel like they have control over the market tend to make more profits in the long run. So add the VIX to your investing tool box, and use it at times of volatility.
Best of luck with your investments.
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