Fearful Investors Use The Volatility Index (VIX) to Sidestep Bear Markets
She didn’t cry at first, but when she saw the first tiny bit of blood, she was screaming as loud as possible.
My 4-year-old daughter was racing around on her scooter that she got for Christmas.
She has been riding it for a couple of months now, so she is pretty good. We eventually took off the knee, elbow and wrist pads and let her keep up with her big brother.
Then she crashed.
Skinned up her knees. And now we are back to padding her up.
It’s not a worst-case scenario. She didn’t hit her head, she didn’t break a bone. But it is likely what many investors are going through right now — a reality check.
The latest stock market correction was just like skinning up your knees playing outside — it’s part of the game.
There are ways to limit the impacts of it, though, like hedging your positions, using a diversified strategy and taking some profits as they come. But, in the end, the risks remain.
For some investors, maneuvering a volatile market environment isn’t your thing. And the possibility of a bear market scares the heck out of some of you.
I know because I read your emails and have had conversations with many of you at our annual symposium. The biggest concern is losing money.
That’s why today, I wanted to share with you a quick, simple strategy you all can implement to sidestep a bear market. Let me explain…
A Simple Rule
You all are going to read this and think that if it’s so easy to dodge a bear market, why doesn’t everyone do it?
Well, there are enough people in the world like me who want to trade the market, buy the dips, hold solid stocks and continue to play the stock market game — it’s what I love to do, and for others, it’s a rush.
But for those of you looking for an easy way to get out before the bear market ensues, here you go:
Go to cash when the CBOE S&P 500 Volatility Index (VIX) is above 25.
That’s the only thing you have to follow if your sole fear is going through a bear market.
Remember, a bear market brings losses of 40% to 60% over just a year or two. This strategy can help you sidestep that drop.
After all, a drop like that can be devastating to someone who can’t leave those funds invested to benefit from the eventual bull market that would follow.
But by following that simple rule above — going to cash when the VIX is above 25 — you would miss the blunt of a bear market.
Sleep Easy at Night
Don’t get me wrong, you still are going to go through some corrections.
For example, you would have been invested through the recent dip in the markets. But you could sleep easy knowing you exited with a 10% decline in your portfolio instead of a 40% to 60% plunge that the markets would experience in a bear market.
Now, the downside to using a simple rule like this is that you don’t get back into the market until the VIX is back below 25.
That makes following this strategy through the ups and downs underperform the S&P 500 over time. That’s because by the time the VIX is back below 25, you have missed out on the rebound of the stock market, which sees some of the fastest gains for the entire bull market.
But at least you would be sitting in cash, waiting to find the ideal entry point.
You could either try timing a market bottom, gradually investing funds once the market drops significantly, or sleeping well knowing your money is earning interest and didn’t plunge 50%.
Whatever works better for you.
At least you know how to sidestep a bear market if that is one of your No. 1 fears.
Chad Shoop, CMT
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