zentrader.ca / By Chris Ebert / February 10, 2013
Option Index Summary
Why is it that stock prices sometimes go up one day and down the next, without any significant news event in the market that would explain the two moves?
How is it possible that stock prices sometimes go up when there is bad news, and down when there is good news?
Just who or what is it that is making the market behave the way it does?
Some may conclude that “evil” bankers are the cause, or some sort of covert government influence is at work. Others would consider those to be outlandish ideas. But it truly does not make a difference – good and evil are irrelevant when it comes to understanding how the stock market works. An evil Wall Street tycoon or a benevolent trader of a retirement account are both slaves to the emotions of greed and fear. And since greed is really just the fear of missing out, the only emotion that matters is fear; and fear affects all humans, both good and evil.
“The only thing we have to fear is fear itself”
When Franklin Roosevelt spoke his famous phrase “The only thing we have to fear is fear itself”, he probably did not have the stock market in mind. But that little bit of wisdom can be a great benefit for a trader who is attempting to gain an understanding of the market. Fear is what trading is all about.
There are lots of ways to measure the effects of fear. Most technical indicators are actually fear gauges. Perhaps the most common of these is the VIX, the so-called fear index. But the VIX tends to only measure fear once it is present.
Many times, once fear has increased it is already too late to take action. The scenario usually involves a drop in stock prices that make up a broad index such as the S&P500. When prices fall, fear increases and the VIX usually rises. In this scenario the VIX isn’t indicating anything traders don’t already know. They know prices have fallen, they know traders are fearful of further declines, they probably are fearful themselves.