The FTSE 100 index has charged higher recently and with the Bank of England cutting interest rates to 0.25% and increasing its quantitative easing programme last week, UK investors might be thinking that now is the ideal time to buy stocks. Personally, I’m not so convinced that now is the time to be committing all your investment cash.
That may sound like very un-Foolish advice. But I’m not saying don’t buy shares – just have cash ready for when prices are at their keenest.
As a contrarian investor who looks to buy stocks when there’s panic in the air, I always keep an eye on a very useful indicator, the CBOE Volatility index or ‘VIX’ as it’s commonly referred to, which measures investor sentiment and market volatility.
Right now this index is trading at a concerning level, and if you’ve been thinking about buying shares in the near future, I’d urge you to read this first.
The fear index
The Volatility Index (ticker VIX), also known as the ‘fear index’, is a popular measure of investor sentiment and market volatility. The VIX is calculated on the prices of options on the S&P 500 index and shows the market’s expectation of 30-day volatility. It sounds complicated but in reality it’s very easy to understand: when markets are volatile, the VIX spikes higher and when markets calm down, the VIX falls.
VIX values of greater than 30 are generally associated with high levels of volatility and investor fear, while values below 20 correspond to calmer periods. The chart below shows the VIX over the last decade. We can see that the VIX spiked as high as 89.5 during the Global Financial Crisis, while in January this year when markets plummeted, it hit a level of 32.1.
Source: marketwatch.com
Fear and greed are the dominant emotions in the world of investing, and investors who have the discipline to buy shares when fear levels are high are often rewarded in the long term. And that’s why the VIX is useful as it allows investors to monitor the level of fear in the market in an attempt to take advantage of market turbulence.
Warning sign
The VIX rose to 26.7 during the Brexit panic, however since then the index has fallen dramatically and is now trading at a level of just over 11. This is an extremely low level and suggests that markets are in a complacent, over-confident mood. In my mind, such a low level of fear is a warning sign that markets may jolt into life in the near future.
Are you prepared for a spike in market volatility?
Be prepared
While I’m not suggesting that investors sell everything and hide their life savings under the mattress, I do believe that it could be a sensible idea to have some cash available on the sidelines. Long-term investors should see volatility as a positive, as it provides opportunities to buy quality stocks at lower prices.
There’s nothing more frustrating than seeing great companies being sold at rock bottom prices, yet having no cash available to take advantage.
I’ve been boosting my cash pile recently while markets are calm, and I’ll be looking to deploy it when opportunities arise.
