"Be fearful when others are greedy and greedy when others are fearful," says investment guru Warren Buffet.

This sounds easy, but the question is, how do we know when we should be "greedy"?

In this article, we will introduce an interesting index called VIX. It works like a thermometer for the stock market as it can often measure changes in market sentiment and help us better grasp market trends.

01 What is VIX

The VIX index, also known as the "fear gauge," is an indicator created by the Chicago Board Options Exchange (CBOE) in 1993 to measure the expected volatility of the US stock market.

The index is based on the S&P 500 index and is calculated using the weighted prices of S&P 500 index options.

Simply put, VIX suggests the degree of market uncertainty. The higher the VIX, the greater the level of fear and uncertainty in the market.

02 Understanding VIX values

How to understand the value of the VIX index?

The VIX index isn’t expressed as a percentage, but we can understand it as one.

The VIX is a measurement of the expected volatility of the S&P 500 index for the next 30 days, with a 68% confidence level.

For example, suppose the VIX index is quoted at 28. This means there is a 68% probability that the S&P 500 will move 28% annually in either direction. If converted into monthly volatility, which means the annual figure is divided by the square foot of 12, we get 8.09%. In other words, there is a 68% chance that the S&P 500 will rise or fall 8.09% over the next 30 days.

Generally speaking, a high VIX reflects more expected uncertainty in the stock market. Conversely, a low VIX indicates low expected volatility.

Historically, spikes in the VIX often coincide with times of crisis.

For example, during the 2008 financial crisis, the VIX skyrocketed to extremely high levels of above 50, showing that the market was in a panic.

The following chart shows the historical trend of the VIX index.

03 The relationship between VIX and the stock market

What's the relationship between VIX and the S&P 500 index?

VIX generally has an inverse relationship with the S&P 500 index.

Historically, if the VIX value increases, the S&P 500 is likely to be falling. On the flip side, when the VIX value declines, the S&P 500 is likely to be rising or stable.

However, this is not always the case. In fact, about 20% of the time, the VIX index and S&P 500 index move in the same direction, according to Marcoption.

So at what level will the VIX indicate a relatively good outlook for the stock market?

As a rule of thumb, investors should pay attention to when the index reaches the following key levels：

● When VIX is trading below 20, the market is expected to be in a period of stability.

●When VIX is trading above 30, the market is projected to go through tremendous fluctuation as the level of uncertainty, risk, and investors’ fear all rise.

According to a report from Capital Group, sustained low levels of the VIX have historically been accompanied by healthy returns in the S&P 500 index.

04 What can investors learn from the VIX?

For most investors, how to use VIX to determine the market direction？

Two signals may help: when VIX closes below a key level of 20 and when VIX falls into a death cross.

According to research by Senior Quantitative Analyst Rocky White, when the VIX falls below 20, it may signal more upside for the S&P 500 index if the market is in extremely strong momentum.

The report shows that if the S&P 500 index gained at least 7% in the past three months before VIX made a more than 20% drop, the S&P 500 went up all four times over the next three months with an average gain of 4.87%. Over the next six months, the index gained 6.88% on average with a positive return every time.

Another signal is when VIX falls into a death cross. It usually suggests stocks are likely to advance over the next 2 weeks.

A death cross pattern appears when the VIX's short-term 50-day moving average slides below its 200-day moving average.

According to the Stock Trader's Almanac, there have been 35 death crosses for the VIX since 1990. The S&P 500 climbed an average of 2.5% in the next 60 trading days following the signal.

05 Bottom Line

VIX is an important index that helps investors observe market risk and investor sentiment, predict market trends, and adjust trading strategies.

Here is the summary:

● VIX gauges the level of fear in the US stock market. The higher the VIX, the greater the level of uncertainty in the market.

● In general, the VIX index tends to have an inverse relationship with the S&P 500 index.

● Two signals may help investors determine the market direction with VIX: when the index closes below a key level of 20 and when VIX falls into a death cross.