What is VIX and how to interpret VIX for profitable trading?

One of the best ways of profiting from India VIX Futures is by going long at lower levels ahead of a major event that promises to make markets volatile.

Volatility measures the frequency and magnitude of price movements that a financial instrument experiences over a certain period of time. VIX is a real-time volatility index which reflects the volatility expectation of the market participants over the next 30 calendar days. It is often referred to as the ‘fear gauge’ and is used by investors and traders to ascertain the market moods before making investment or trading decisions. India VIX is computed by using the best bid and ask quotes of the out of the money, present and near month Nifty 50 option contracts. Higher the India VIX, higher the expected volatility and vice-versa.

Suppose Nifty 50 is trading at 17,000 and VIX is currently at 25. It can be interpreted as a probable annual variation of 25 per cent in the next 30 days. It is critical to remember that the variation is annualised and the monthly variation comes close to 2 per cent. This essentially means that Nifty can move in either direction by ~350 points. The reason why VIX is paramount for investors and traders alike is that it is a good measure of expected volatility and indicates whether the market participants are feeling complacent or fearful about the near future.

There is a negative correlation between India VIX and Nifty 50. VIX tends to drop when Nifty goes up, and vice versa. Investors who are worried about markets going down can hedge their equity portfolio by buying India VIX Futures. Investors can also short the India VIX Futures in case they believe that India VIX has peaked. One of the best ways of profiting from India VIX Futures is by going long at lower levels ahead of a major event that promises to make markets volatile.

As an investor or trader, market sentiment indicators can be your trusted companion in the journey of wealth creation, only if you know how to read and interpret them correctly. The stratagem to outperform markets is to understand VIX reading accurately and then adjust your trades and positions accordingly.