Watching the stock market over the last couple of weeks reminds me of The Cyclone at Coney Island – dramatic ups and downs, and all the passengers get knocked around a lot. If you’re worried about the relative degree of risk the market presents today, or at any point for that matter, there are a couple of short term measurements that have proven themselves reliable indicators of market risk.

These two indices won’t themselves enable you to realize big profits, but they definitely can help you better understand where the market stands and may help you avoid being overly optimistic or pessimistic.

1.  NYSE 10 Day High-Low Average

This indicator tracks the number of NYSE stocks hitting 52 week highs versus those hitting 52 week lows, averaged out over a ten day period.  For example, if 225 stocks reached their highest prices of the past year, and 20 hit their lowest prices, the index would be at 91.8% (225 ÷ 245).  As the chart below shows, the market is considered to be Bullish when the 10 day Average is above 85% (the blue line is the 10d High/Low Index):

This particular chart is handy in that it indicates when the reading has turned bearish, and when the trend is positive or negative.

An explanation of this index from the MarketGauge website:

The number of stocks reaching a new 52-week high relative to the number of stocks falling to a new 52-week low is a measure of the market’s breadth. In a healthy market an increasing number of stocks will make a new high as the market climbs. In the late stages of a bull market the advance “narrows”, meaning fewer issues reach new highs along with the major indexes. Similarly, the end of a bear market is evident when the number of new lows decreases even as the market declines.

If you’d like to track this indicator, you’ll find this link useful:  MarketGauge – NYSE 10 Day High Low Index

2.  VIX Volatility Index

You likely have heard of the VIX.  The CBOE (Chicago Board Options Exchange) Volatility Index is an indicator for how much fear investors exhibit with regard to the future direction of the S&P 500.  From the CBOE:

The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, VIX has been considered by many to be the world’s premier barometer of investor sentiment and market volatility.

When the market and trader action is characterized by anxiety and fear, the VIX rises; when market conditions (and trader confidence) improves, the index generally falls. Here’s a somewhat lengthy explanation from OptionTradingpedia:

The VIX is quoted as a percentage estimating the implied volatility of the market, which is the expected annualized movement of the S&P-500 over the next 30 days. Not to get too technical, when the VIX is at 30, it means that the S&P-500 might move as much as 2.5%…  up or down over the next 30 days.

As a contrarian indicator, the higher the VIX, the more bearish the market is and conversely, the lower the VIX, the more bullish the market is.

The real question now is, when is the VIX high or low?

There really isn’t a standard to what constitutes a high or low VIX reading. Apart from using your experience and gut feel, there are 2 main ways to read the VIX. 1, Multi-years high or low. 2, VIX trend.

Multi-year highs or lows typically warns investors that turning points may be near. The above examples marked two market reversals when the VIX was in multi-year high and low. Investors and traders may consider covering or closing profitable positions when these points are reached.

The trend of the VIX also provides an indication to the trend of the stock market. In a bull market, the VIX is typically trending downwards and in a bear market, the VIX is typically trending upwards. The VIX was trending downwards steadily in the big bull run of 2003 to 2006.

In simplest terms, when the VIX gradually declines from levels in the 20’s or higher down to 20 or below, it usually indicates a stable market and low volatility – and is thusly considered bullish.  Higher readings – say 35 or higher – are a sign of increased volatility. To put things in perspective, the VIX hit its all time high of 89.53 on October 24, 2008.

If you’re interested in tracking the VIX, click here for a 12 month chart:  VIX 12 month chart

I hope you find these two indices helpful as you sort through your investing options and try to make sense of where the market is headed.

P.S. Coincidentally enough, this from today’s MarketWatch:

All information provided in this post is for informational purposes only.  Practical Hacks makes no representations as to the accuracy, completeness, suitability or validity of any information in this post or on this site, and will not be liable for any errors or omissions in this information or any damages arising from its display or use.  Please seek the advice of a qualified investment advisor before making investment decisions.

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