Two simple short-term measurements have proved to be effective and reliable indicators of the risks associated with investing in the stock market. Following these indicators isn’t a way to get rich quick. But over time, they can help save you from being too optimistic and getting burned or being too fearful and missing out on potential profits…
10-day high-low average: This indicator tracks the number of New York Stock Exchange stocks hitting new 52-week highs in price divided by the total number making new 52-week highs and lows.
Example: If 100 stocks reach their highest prices of the past year and nine hit their lowest, then the high-low average is 92% (100 ÷ 109) — where we were recently, down from 99% in early 2009.
Why it is useful. You want to be heavily in the stock market whenever this indicator is rising and hits 90% or more. That’s because more and more stocks are participating in the rally, investors are pouring money into the market and it’s gaining strength. However, when the indicator drops below 80%, it’s historically been a good time to reduce your positions.
You can find these figures each day at The Wall Street Journal online market data center (www.wsj.com, click on “Markets,” “Market Data” then under “US Stocks,” click on “New Highs & Lows”).
VIX: This is the ticker symbol for the Chicago Board Options Exchange Volatility Index, which is a popular measure of how much fear investors have about the future direction of the S&P 500.
When a large number of traders become fearful and sell indiscriminately, VIX levels rise. The index hit an all-time intra-day high of 89.53 on October 24, 2008. When market conditions improve, stock price movements generally become more orderly and the index declines. The end points of market declines are frequently signaled when the index rises to very high levels, perhaps 40 to 45 or more, and then turn down, indicating a reduction in market instability.
Why it is useful: A gradual decline from levels in the 20s or higher down to levels of 20 or below usually indicates a more stable stock market and may be a bullish signal. However, if the VIX declines to very low levels, perhaps 10 to 12, this often is an indication that investors have become too complacent, and it may be a bearish sign for stocks.
Example: The VIX dropped to as low as 10 in 2007, just a few months before the start of the 2008-2009 bear market. Recently, the VIX has been between 18 and 20, which generally indicates a stable market. Investors should get nervous if the VIX drops again to 10 to 12 or rises above 25.
You can find the current VIX reading at www.cboe.com/VIX.