Decoding Wall St.​: What the Heck is the Vix Index and How Do You Make Money from It?

Before we are even able to decode the Vix index, the foundation has to be set on a couple key investing concepts.

Contrarian investing: Anyone that considers themselves a contrarian investor is the real-life equivalent of being a red duck amidst a group of white swans. The contrarian investor looks for what is called a “consensus opinion” held by Wall Street’s top minds and then develops a completely opposite position (sound smart: “stance”). Here, the red duck is trying to profit from the white swans being very wrong (in practice, the white swans are the individuals expecting XYZ economic event to happen and invest accordingly; the red duck is expecting ABC event, and invests accordingly). A present day example of being a contrarian investor would be to invest as if the U.S. housing market was going to hit the skids in 2012, which is counter to the opinion held by many that the housing market is on the mend. To position oneself to profit, the red duck would “go short” a stock of a company tied to housing’s fortunes (expecting the particular asset purchased to lose value), perhaps a Home Depot or a Lowe’s.

Fear in the marketplace: Anytime you see the word fear attached to a story on the stock market expect it to reference the VIX index, not anything related to Freddie Kruger showing up on the NYSE (be smart: New York Stock Exchange) trading floor.

Those in finance tend to simply explain the VIX index as the “fear gauge” or a “measure of stock market volatility.” To that, we offer a “huh?” The bullet points below are what we want you to remember on the VIX index.

1. VIX index: A measurement that tries its mightiest to gauge if stocks will rise or fall in value in a short time span. For a more advanced explanation, feel free to reach out to us.

2. The basic concept: The VIX index will magically appear in the paper when (1) stocks are rising and people are looking for a reason to cash in profits (sound smart: stocks are “overbought”); or (2) stocks have gone down in value and people are looking for a reason to buy stocks (sound smart: stocks are “undervalued” or “under-owned”).

Now that we laid the foundation, the Vix index should be much clearer. First of all, the discussion arrives on the scene at a time when the S&P 500 index is at a four-year high and Dow 13,000 is making the local newspapers (insider fact: if the value of a major stock index makes a front page of a local newspaper, it’s said to quietly represent a “market top”, or a point where stocks could go down). With stock prices having advanced quickly at the still early stages of the year, and most on Wall Street expecting the “rally” to continue, it’s a period in which the contrarian investor will likely seek out the VIX index to support their more bearish (negative) assessment on the direction of stocks. The VIX is playing tricks on the contrarian investor currently, however.

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