It’s been a crazy last two weeks as volatility has re-appeared in the market after a multi-year vacation. All the sudden I’m remembering that day back in October of 2002 when the NDX (which had been over 4,800 just 30 months ago) and the S&P 500 (which hit it’s high above 1550 around the same time) converged with the same price near 800. The market can be a brutal place for anyone’s money, and runaway moves always go farther than most think is possible. So my post today is not highlighting a stock long or short but instead urging investors to use a generous helping of caution as they trade through these turbulent times.

Many people have noted the rise in the VIX index which represents volatility in the overall market. In case you wonder, the VIX is a statistical measure of the premium in calls and puts on the OEX index. (if i’ve already lost you, just move on to the next paragraph). As option traders recognize the market swings are becoming wider, they will be willing to pay more for an at the money option as the increased volatility means they have a better chance of being “right big.” Also sellers of those options need to be compensated more for the risk they are taking as the market can wipe them out “big” when it is trading wildly. Usually, volatility is associated with a declining market, but there is not a fail safe level on the VIX that signifies the worst is finally over.

Extreme VIX readings appear near market bottoms. That is because people usually panic, and so volatility soars, and the amount traders need to be compensated for the risk they are taking skyrockets. But please don’t look at a new high on the VIX and assume it is ok to buy. Instead look for the VIX to hit a new high and reverse, and also look for the market prices to begin to bounce after a severely negative selloff. This is kind of like waiting to see the “whites of their eyes” before firing. Even then, I would only put a portion of capital at risk as bear markets are littered with false rallies.

The most important thing is to exit a period like we are in now with most of your capital. That allows you to make gains when the environment is better instead of spending the next 6-12 months making back what you have lost (or even worse getting wiped out.) So please let me urge you to stay off margin for the time being, play it close to the vest, and live to fight another day. There’s lots of opportunity being created out there. Just be patient and know the risk involved with any position.