Are you like most Americans and looking at the markets and wondering what will happen next? If so you are far from being alone in this process. It would be an understatement to say that over the last few weeks the market has had its up and downs. Let’s face it, the market is acting as it usually does in August and September if you look at historical data. This is the time of the year when the markets make a pullback and rebound in late October or November. But that does not help many in this volatile time when it comes to their investments. First do not panic and sell while these events are happening. Follow Warren Buffett’s saying in times like these and be greedy when other are fearful. This volatile times can and do create some tremendous buying opportunities if you are in a position to take advantage of these large dips in the markets.

So how do you know when the markets are entering a volatile state? One way is to watch the Volatility Index or VIX. The VIX is a contrarian indicator that tries to tell people when there is too much optimism or fear in the markets. When this sentiment reaches one extreme or another, the markets will typically reverse their course and head in the opposite direction.

The VIX is based on the options associated with the S&P 500. The key question that the VIX answers is what is the implied or expected volatility of the options on which the index is based. With the following variables known that are components of the VIX we can solve for the implied or expected volatility. The known variables are the market price of the S&P 500, the prevailing interest rate, the number of days to expiration of the option series, and the strike price of those options.

So what is volatility? In simple English terms it is how fast prices will move. When the markets are calm or even moving in a trading range the VIX is typically low. On days when the VIX is low, it means that call option buying is outnumbers put option buying. What that means is the market is complacent and is lacking overall fear. On the flip side, when the market is selling off and put options outsell call options the VIX will increase showing fear in the markets.

The VIX is one of many market indicators that when used in conjunction can aid someone in seeing a possible reversal in the market. Each person uses different indicators so the best thing if to research market indicators and find the ones that will fit in your analysis.

An example of the VIX and how it reacts to a volatile market can be seen from the last two weeks. On Monday August 17, 2015, the VIX closed at 12.83 which leads one to believe that the markets are in harmony and relatively calm in nature. Then just one week later the VIX closed at 40.74 on August 24, 2015, showing that they are turbulent and uncertain feelings regarding the markets. That is an increase of 218% in one week and if you need further proof that the markets were indeed in turmoil the DOW went down almost 1,500 points in that time frame. A major shift in what people were thinking and expecting as shown by the dramatic change in the VIX.

But please remember that August, September and October are poor performance months for the markets, and they tend to bounce back in November and December. While the VIX shows volatility, it is not the only indicator you need to be aware of. There are several and people tend to use the ones that make sense to their investing strategy. Never rely on one indicator and always remember to not panic when the market makes a change in direction. Historically the markets have always come back with some being faster than others.

If you have any question or need additional information, please feel free to contact me.