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Tuesday, September 23, 2008

VIX: CBOE Volatility Index Signals Fear is High

This VIX chart shows that buying equities when the the Chicago Board Options Exchange (CBOE) Volatility Index has been above 35 has worked out very well for short term gains even during the March 2000 to October 2002 bear market.

"Buy when there is blood in the streets"
Nathan Rothschild, the British member of the Rothschild banking family in the early 19th Century commenting on the best time to buy. He is reputed to have made a fortune from the Battle of Waterloo stock market panic. His full quote is believed to be "Buy when there is blood in the streets, even if the blood is your own."
Click chart courtesy of for full size image

Currently the VIX is at 33.80 but it spiked to 42.5 last week. I was a buyer for my own accounts last Wednesday, Thursday and Friday. To learn what I bought for my newsletter explore portfolio last week and what I recommend now, subscribe Today!!

One could give in to the fear, cash in your stocks and buy CDs, (CD rates,) money funds, US Treasuries (US Treasury Rates) or even gold, but over the long term, stocks have out performed. What better way to boost your returns than to buy when the markets are 25% or so off their peaks? [See Market Update for September 21, 2008.]

Using periods of major market weakness to rebalance is not market timing either. Why wait for January 1, 2009 to do your "annual rebalancing?" The markets could recover significantly by then. See the article "Using Asset Allocation to make money in a Flat Market" to see how that works.

Definition: The VIX is the Chicago Board Options Exchange (CBOE) Volatility Index. The VIX shows the market's expectation of 30-day volatility. It is calculated from both calls and puts that are near the money. The VIX is a popular measure of market risk thus making it another great contrarian “fear indicator” useful for short-term market timing.

Market Timing Disclaimer: No sentiment indicator, or any indicator for that matter, is 100% reliable. I look at sentiment as head winds and tail winds. When sentiment is terrible, then it acts like a tail wind for your returns where you could see further declines, but long term, it is best to be buying when most others are selling. Likewise, if we see sentiment get too bullish, then I would consider lowering my portfolio asset allocation. It seldom pays to be buying stocks when EVERYONE is talking about stocks and how much money they are making at cocktail parties.

In addition, I am not market timing but for a small portion of my explore portfolio. I use market-timing indicators to tell me it is a good time to buy so I can add to positions when the market is down and thus help me overcome my fear to rebalance back to my target asset allocation. Likewise, when the market-timing indicators are saying to sell, they usually come when the markets are high where I want to be taking profits. The market timing indicators at market highs help me get over my greed and take profits. Now and then, I may make an asset allocation adjustment based on the Fed Model saying the market is over or under valued. Some call that market timing, but I do not. Also, I have stayed pretty close to 70:30 equities-fixed for many years despite the Fed model which has its own set of flaws.

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