Lessons from the Pros

India Markets

Volatility, an Odds Enhancer?

Volatility is a measurement of how far the price of a security might move in the future. If there is high volatility, then there should be large swings in price and fast movement. When volatility is low, prices are expected to remain relatively stable. Investors dislike volatility and would rather place their money into a stable market. So when volatility rises, the nervous investor will tend to withdraw money from the share market in favor of a safer investment.

There is a measure of volatility that we can use for the broad market.  The India VIX is a measure of implied (future) volatility for the Nifty.  The India VIX can be charted on a graph and can range from zero to well over 60, but readings over 40 are rare.

When the Nifty drops in a bearish trend, the India VIX will rise dramatically.  When the volatility index reads near or above 30, the panic has reached a frenzy.  This combined with the Nifty reaching a demand zone could indicate a bottom in price.

The opposite is also true, when prices are rising in a bull market, the volatility drops as investors become complacent.  If the India VIX drops below 20 and price reaches a supply zone, there may be a selloff soon.

As you can tell from my statements, the India VIX should not be used by itself.  It is not infallible and can be used as an odds enhancer when deciding potential price action of the markets when at supply or demand zones.  Typically, the volatility index will move opposite of price, but volatility can also rise with a fast upward price movement or fall with a slow downward price drop.

The India VIX is going to be more useful for a longer term investor who is trying to identify changes in trend.  But volatility is also an excellent tool for the options trader.  Volatility is a major factor that influences option premiums.  Changes in volatility can disrupt the unsuspecting options trader and can cause losses even when the direction chosen was correct.  Next week I will look at the volatility effect on Indian options markets.  Until then may all of your trades be green and your losses small.

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

Join over 170,000 Lessons from the Pros readers. Get new articles delivered to your inbox weekly.