The “Law of Volatility” at Work
It didn’t take long for investors to forget about risk… but the DailyWealth “law of volatility” will remind them.
There are few sure bets in the financial markets… and few definitive “this is the case, and it always will be” statements we’re comfortable making. But one we’ll stick by forever is, “Calm periods of rosy headlines and softly rising prices will always be interrupted by periods of wrenching volatility… and vice versa.” That’s just the way the world works. Statisticians call it “reversion to the mean.” #-ad_banner-#
For a picture of this “always the case, always will be” phenomenon, we present the past three years of the Volatility Index (the “VIX“), the most popular gauge of market volatility and investor fear. When the VIX is low (below 18), it indicates investors have few worries and see blue skies ahead. When the VIX is high (above 30), it indicates panic and confusion.
In early 2010, investors were enjoying the “good times” of the market recovery. The calmness was shattered by the flash crash (spike “A”). In mid-2011, investors were enjoying another calm period… which was shattered by the European debt crisis (spike “B”). As you can see in the lower right hand corner of our chart, the VIX has plummeted in the past three months. It’s just a matter of time before a new crisis catapults the VIX higher.