Relative Value Trading: My Fav. Economic Indicator Series: Today is VIX

Thanks for the feedback folks. Your comments have helped me decide the direction for the blog. I am going to have some daily updates about what's going on and at least on a weekly basis I will have some trade ideas. Also, I will answer questions whenever I don't have too much to write about or when a situation lends itself to a particular question.

My Favorite Economic Indicators:
I am researching links between macroeconomic variables and hedge fund returns. Naturally, the examination resulted i me revisiting my old friends ( the indicators) and some new ones. I will cover economic indicators for a few days. Today, I talk about VIX

VIX: Approximates the expectation of the volatility i.e. how much movement (going up or down both count for movement!) in the S&P 500 stock market index is expected. Naturally, there is more movement expected in more volatile times. Some people call it the "fear" index. If there is a lot of movement; the market is up one day and we think the worst is over; the market tanks the next day with news of yet more writedowns by banks and we get nervous. This uncertainty makes people unlikely to want to buy stocks. Also, when such "shocks" (in the form of bad news) occur people naturally get less optimistic about the future growth of companies. The stock market is forward looking and less optimism about future growth lowers the prices! Thus typically there is a negative correlation between an increase in VIX and the stock market levels ( and returns).
Range: When VIX jumps above 30 really bad times are here. If you are brave enough you can take a long position and make money. However, remember the market could continue to go south and bottom picking/catching knives can be dangerous!
Yahoo Finance Symbol: ^ VIX
Why I like it? : VIX tells me what the options traders think about the stock market. Currently, the U.S. stock markets are moving the world and VIX is a good predictor of what will happen to the FTSE, BSE, Nikkei, CAC40 etc.
VIX and Currencies: When VIX increases, typically the high interest rate currencies ( example NZD, the New Zealand dollar with interest rates around 8% , will drop in value and the low interest rate currencies (JPY- the Japanese Yen with rates 0.5% ) will increase in value. There are a number of reasons for this phenomenon.
a) Many hedge funds like to borrow in the low interest rate currencies and "invest" in the high interest rate ones and it is called the "Carry Trade". When there is panic and fear in the financial markets then speculative positions are unwound quickly.
b) Fundamentals: There is many times a reason for the panic! When economic fundamentals are weak ( our economy now is a good example) then investors may not want to invest in that particular country anymore. Investors may conclude that there could be runaway inflation and the possibility of a currency crisis is increased.