What the Volatility Index Says About the Economy and Markets

Editor's Note: This story originally appeared on NewRetirement.

While the S&P 500 is still well above where it was last year, stocks are faltering — despite some good economic news. Wouldn’t it be nice to have a crystal ball to tell you where the market is headed next?

Well, the Volatility Index can provide some clues.

The Volatility Index, formally known as the Chicago Board of Exchange Volatility Index and VIX for short, is a gauge that measures how nervous the markets are. More specifically, it tracks how much investors expect S&P stock prices to fluctuate over the coming month.

It is important to note that the VIX doesn’t predict future stock prices. It simply suggests whether there is likely to be volatility — price changes — in the near future. Find out what it has to say.

How Does the VIX Work?

The VIX tracks the options market where traders are trying to make money by predicting the future performance of stocks and other securities.

When the VIX is high, it means that investors expect prices to move around a lot. There is greater uncertainty.

When the VIX is lower, it suggests that there will be greater stability.

How Is the VIX Useful?

The VIX can be a good indicator of how nervous investors are. However, most people should think of the VIX as interesting information, not a call to action.

It is probably not a measure to be used by ordinary people to determine buy and sell strategies.

In fact, your overall asset allocation and buy and sell decisions should probably be determined by a long-term strategy focused on achieving your goals, not on any one short-term index.

Learn more about building an investment policy statement, a document defining your investment goals, strategies for achieving those objectives, a framework for making changes to your plan, and what to do if things don’t go as expected.

What Does the VIX Say About the Current Economy?

On Jan. 27, 2022, the VIX closed at around 30. (You can track the VIX here.)

That is a tricky reading. In general, when the VIX is at 12 or lower, the market is predicting low volatility.

When the VIX is above 20, it suggests high volatility. And, when it is above 30, that is indicating that the markets are particularly unsettled.

So, 30 might be concerning. It is well above the average of about 18-19 from the last 15 years. However, it is also very much below the readings of 80+ that were seen during the global financial crisis of 2008-09 or March 2020.

There is certainly good news to be had. U.S. gross domestic product (GDP) rose more than expected at the end of 2021, and first-time unemployment filings are down.

What Are Reasons to Worry About the Financial Markets?

There are reasons for uncertainty:

• Inflation is persisting longer than economists had hoped.
• The Fed is considering an interest rate hike to combat inflation.
• On the geopolitical front, tensions are high between Ukraine, Russia and NATO.
• The pandemic persists.

What to Do if the Stock Market Falters

The best thing to do if the stock market falls (or rises) is to stick to a plan. Don’t have a plan? To get started, here are 10 surprising moves to make when stocks go down.

Most importantly, just remember that a good offense against financial losses in the market is a great defense (a forward-thinking plan that addresses what you will do under different market conditions). You want to understand what could happen and know, in advance, how to react.

Use the NewRetirement Planner to assess different scenarios for rates of return on your investments and assess your chance of retirement success.