risk management Archives

Volatility is a term that describes how much the prices of financial assets fluctuate over time. It is an important concept for investors and traders. This is because it reflects the level of risk and uncertainty in the markets. High volatility means that the prices can change significantly and unpredictably in a short period of time. Low volatility means that the prices are more stable and consistent. One of the most widely used indicators of volatility is the CBOE Volatility Index, or VIX.

Also known as the “fear index”. The VIX measures the market’s expectation of volatility over the next 30 days, based on the prices of options on the S&P 500 index, which is the benchmark for the US stock market. It is calculated and updated in real time by the CBOE and is expressed as an annualized percentage.

The Makings of the VIX

The VIX is derived from the prices of both call and put options on the S&P 500. A call option gives the buyer the right, but not the obligation, to buy the underlying asset at a specified price (the strike price) before a certain date (the expiration date). A put option gives the buyer the right, but not the obligation, to sell the underlying asset at the strike price before the expiration date. The prices of these options reflect the market’s perception of the probability and magnitude of the future price movements of the S&P 500.

The VIX is calculated using a complex formula. It takes into account the prices of various options with different strike prices and expiration dates. The formula essentially aggregates the implied volatilities of these options, which are the volatilities that are implied by the option prices, rather than the historical volatilities that are based on the past price movements. The implied volatilities are weighted and averaged to produce a single number that represents the market’s expected volatility.

The VIX as a Measure of Fear

Generally, a high VIX indicates a high level of fear or pessimism among investors. It means they expect large price swings and are willing to pay more for options to hedge or speculate on the market movements. Conversely, a low mar indicates a low level of fear or optimism among investors. It signifies that they expect small price changes and are less interested in options. The VIX is inversely correlated with the S&P 500. Usually, when the VIX goes up, the S&P 500 goes down, and vice versa.

The VIX is not only a measure of volatility, but also a tradable instrument. Investors and traders can use various products, such as futures and exchange-traded funds (ETFs). These let you gain exposure to the VIX or to hedge against volatility risk. For example, one can buy VIX futures or options to profit from an increase in volatility. Alternatively, one can buy or sell ETFs that track the performance of the VIX or its inverse, such as the iPath S&P 500 VIX Short-Term Futures ETN (VXX) or the ProShares Short VIX Short-Term Futures ETF (SVXY).

To Sum it Up

The VIX is a useful tool for investors and traders who want to measure and trade volatility in the market. However, it is not a perfect indicator, as it is based on market expectations and not on actual outcomes. Therefore, it is important to use the VIX in conjunction with other tools and indicators, such as technical analysis, fundamental analysis, and economic data, to get a more comprehensive and accurate picture of the market conditions and trends.

You can treat it as another lens to use while looking at the markets.

We’ve all been there—one minute you’re just going through your day as usual and the next minute you’re swept off your feet by the sight of something breathtaking. Without any warning, the pretty girl walking down the street smiles at you; or the cute guy in front stops to hold the door open for you. In the same way, you might just be browsing your news feed when suddenly you see a stock chart that’s about to break out at any moment. You feel a rush of adrenaline and, without waiting another second, decide to go all-in.

Sometimes, we get blinded. We fall hard and we feel in our gut that this is it. We put everything we have on the line and just hope for the best. Sounds romantic, right? But is that really how we should be making our decisions? Can we trust ourselves to make the right choices in these situations?

In many ways, stock picking is very similar to dating. When we see a person or a stock that we really like, it’s exhilarating. We get so excited that we don’t realize how dangerous the situation is. We make impulsive decisions and invest much more than we should. We dive too deep too quickly—all without getting to know the person or the stock at all.

It’s true, there are times when we have to take risks, both in dating and in trading, but that doesn’t mean we can’t make smart decisions about when to jump in and when to hold back.

Before you go all-in, here are three important things you should know before risking it all:

1. It doesn’t have to be all or nothing

Sometimes, excitement can get the better of us. We see something we want and we want to have it right away. We feel like if we don’t grab the opportunity now, then it will be gone forever. While that is true in some cases, it’s not true for all of them. Often, we can easily take things one step at a time without any real consequences.

In dating for example, you don’t have to propose right away when you meet a beautiful woman. You can start by asking her out on a date and getting to know her. If you get along, then you can go on more dates and eventually, when you know each other very well, you may even get married.

In trading, if you see a stock with potential, then buy a few shares first. Monitor it to see how it performs. If things go well, then buy more shares. Wait for positive signals each step of the way and build up your investment slowly. There might be some opportunity cost if the stock performs very well, but at least you won’t lose all your money if the stock performs badly.

2. High risk, high reward

We’ve all heard the saying, “High risk, high reward.” But how many of us really understand what this means? It means that you will first have to take a big risk if you want the possibility of getting a big reward. The key word here is “possibility.” It does not mean that if you take a big risk then you will get a big reward. (Oh, how we wish!)

Yes, it’s true that sometimes things work out and the risk pays off. It’s easy for us to see the positive side because we see it all the time—in movies, TV shows, and even the news. Everyone is constantly talking about the success stories of people who took big risks that paid off—and that’s great! Especially when we’re struggling, we want to know that there is hope and that good things can happen. The problem is that a lot of people act like all stories will end this way, and that’s just not true.

Stephen King said, “Hope is a dangerous thing. Hope can drive a man insane.” Do you agree? Isn’t it true that people are willing to risk it all, in love and in stocks, because they have hope that it will all pay off? Maybe a little too much hope? Hope is good in small doses, but when there is too much, it becomes very dangerous. Too much hope makes people lazy. They become convinced that things will work out, so they don’t bother putting in the work. They forget that success in dating and in stock trading are not based on one “big break”. Both require time, dedication, patience, and so much more.

Don’t fall into this trap. If you’re going to go all-in, know what you are risking and know that there is a very real chance that you could lose it all. Ask yourself: If this doesn’t work, will I be okay with that?

3. Information is power

Once you’re sure that you really want to go all-in—whether your risk ends up paying off or not—then it’s time to be smart about it. You don’t have to go in blind. Do your research. Do the work, and you’ll give yourself a much higher chance of success.

For example, if you want to win a girl’s heart, you have to get to know her first. Find out what makes her smile or what her favorite flowers are. Find out about her fears and dreams. That is how you can give yourself the best chance at success.

It’s the same with stocks. Before you go all-in, you should do your research first. Study the company’s history. Find out what their plans are. What is the best price where you should buy? At what price should you sell? What is your cut loss point if things don’t go your way? What signal will confirm if your theory is right or wrong? These are all questions you need to answer, so that you are prepared to give yourself the best chance of success. Don’t just invest all your hard-earned money and then leave it up to the market. You can increase your chance of success. That’s what they call calculated risk, and that’s also why investing is not the same as gambling.

So whether you’re going after the man or woman of your dreams, or that perfect investment opportunity, always remember:

You don’t have to go all-in. You can take it one step at a time.
If you have to go all in, be sure you know what you’re risking.
Just because you’re taking a risk, doesn’t mean you should be lazy. Find out how to give yourself the best chance at succeeding.

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