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Correlation, Learn To Exploit It

Correlation, VIX Index, S&P500Correlation, VIX, S&P500… In this article, I want to explain to you how important it is to know how to recognize and read the markets in order to deal with them. To do this, a great help we get it from the correlation between the S&P500 and the VIX Index, but especially from their volumes, which affect and clarify the ongoing situation.

 

CORRELATION: comparison between S&P500 and VIX

Before we start, we must understand and know the VIX index, i.e. the Chicago Board Options Exchange Volatility Index, also known as the Fear Index (Ticker: VIX). This index measures the implied volatility of the S & P500 index, it is calculated from the price of the Option on the Index, given all the other variables that combine to form it. Consequently, it depends on the expectations of the operators on what will be the future volatility of the underlying and therefore it is the expected volatility. A sharp increase in historical volatility in the market, often it increases the expected one as well, which is incorporated into the stock price.

The VIX is known as the fear index because when the implied volatility increases, the S&P500 index tends to fall. As the most violent and sudden moves are the downward, normally, if the VIX rises, the markets move nervously downhill as it happened in August and end 2015.

After making a brief introduction of the meaning, importance, and how the VIX index is calculated, let's analyse the correlation between the VIX index and the S&P500 index by comparing the August situation from 18 to 24 with the one from 29 December to January 7. Below an old chart of an old article.

Correlation, VIX, S&P500

 

As you can see from the picture, during the periods of substantial downturns highlighted in the chart, the movements of S&P500 and VIX are opposite as explained earlier, but what I want to point out is this: Why in the summer period, when the S&P500 has collapsed by 13%, the VIX increased by 310%, while at the end of the year when the S&P500 fallen by 9%, the VIX index risen by 72%? What does this discrepancy reason from?

The answer lies in the VOLUME. As you can see in the summer, the volumes on the S&P500 were very high, about 5 million, around 3 million instead at the end of December. That speaks to a lot of frenzies and extremely speculation that differentiates the movements of the instruments in the two periods analysed.

In this article, I pointed out how is important not just to have a trading method, but it is even more important to read between the lines what the market offers us.

The volumes are the secret of everything!

 

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