I have a question for you. How far do you think the INDEXDJX:.DJI (Dow) can go up or down over the course of the next year?
This is a fun one for us because most people will throw out numbers that they may have heard on TV or read in the likes of the Wall Street Journal or Bloomberg. Maybe publications come out with a price target for not only the INDEXDJX:.DJI (Dow), but also the INDEXSP:.INX (S&P 500), or any index or stock in the world for that matter.
We are going to show you that is it not a guess. Financial institutions might send their best and brightest all over the world to give them the edge over the competition in coming up with the most “accurate” price target for the INDEXDJX:.DJI (Dow). While this is great and we have no opinion of how these institutions spend their money, we are going to show you how in about five seconds time, you will be able to know the EXACT expected price move for the INDEXDJX:.DJI (Dow) over the course of the next year. This number will not be a guess and it will be EXACTLY what the market expects and prices in.
How Might We Figure out Just How Far the indexdjx:.dji Might Go?
Let’s try to figure this one out before I go ahead and give you the answer. Let’s think about what it could be.
Here are the 30 components that make up the INDEXDJX:.DJI (Dow). We see we have a little bit of everything. Maybe it would be helpful to know the breakdown of each sector because certain sectors might perform better than other…right?
Maybe we can see which sectors would do better than do some calculation after that?
Or maybe we have to run channel checks, and figure out the potential growth of every country that these Dow components are in, or figure out what their price to earnings ratio is going to be a year from now based off where you think the Dollar might be.
Nope. It is WAY simpler my friends. We need to take a step back first.
What is Volatility?
People associate volatility with the concept of fear. But actually, it is calculated from put buying activity in the $SPX.
The CBOE does all these crazy calculations for the VIX based off of options prices far out of the money on the put side and comes up with a number that we know as the VIX.
But it has very little do with fear in reality. The VIX is not more than the expected move for the S&P 500 over the next year in percentage terms. If the VIX is trading at $20, it means that the market, not some banker, collectively believes the expected move in the S&P 500 over the course of the next year is up or down 20%. That’s it. Nothing more.
But remember, we are more interested in how this works for the INDEXDJX:.DJI (Dow). Below is a simple Google doc that gives live updates for the Dow and it’s 1, 30, 90, and 365 day expected moves completely based off what the market is pricing in. There are no opinions here. Take a look.
If you are reading this article during market hours I think it’s really cool to refresh this page every so often. You will be able to see these expected moves constantly change throughout the entire day. Remember, market move and so do the expectations about future price movement.
How Do We Calculate the Expected Move of the INDEXDJX:.DJI (Dow)?
The VIX is not helpful here, as it is the one year expected move for the S&P 500. We are interested in the INDEXDJX:.DJI (Dow). Fortunately for us, the Dow has its own version of the VIX.
It is time to introduce you to $VXD, the CBOE DJIA Volatility Index. This is to the Dow what the VIX is to the S&P 500.
Now we know that we need the price of the Dow and the price of $VXD. These are the only two data points we need to be able to know instantly what the markets predictions for the expected move for not just over the course of one year for the Dow but also for any timeframe we want.
For example, while writing this article, the $VXD is at $11.92. This means that billions of dollars are betting and agreeing on the Dow to close one year from now somewhere between up or down 11.92%. That doesn’t mean that it will not ever go outside of that range or finish outside of the range, but it does mean that the market expected the price of the Dow to be between up or down 11.92% from where it is right now ($20,700).
Yes, it is simple. Here is the equation the find out the expected move in the Dow for any timeframe.
Dow Price * (VXD price/100) * sqrt(days/365)
The reason the expected move Google sheet moves all day every day is that market expectations also change all day every day. Let’s go thru a few example so we can see exactly how we are figuring out the expected move for any timeframe for the INDEXDJX:.DJI (Dow) using the simple equation above.
|Dow Price||VXD Price||Days||Expected Move||Equation|
In the first example, the market believes with a price of $30,000 and a $VXD of $15, the Dow will close between $31,665.52 and $28,334.48 in 50 days.
In the second example, the market believes with a price of $25,000 and a $VXD of $24, the Dow will close between $27,979.38 and $22,020.62 in 90 days.
In the third example, the market believes with a price of $27,000 and a $VXD of $11, the Dow will close between $27,155.46 and $26,844.54 in one day.
Again, all you need to know to calculate the expected move in the Dow for any timeframe is have the current price of the Dow and the current price of the $VXD.
What Do I Do Now?
Well, first you can thank me.
Then you can get rid of all of that noise that you hear on financial media. Stony Brook Securities does not buy into what financial media or Wall Street says. The VIX is not the fear index, it is just the expected move in the S&P 500 over the course of the next year. The goal of Stony Brook Securities is to cut through all of the nonsense that investors do not need to worry about at all and only give them what is important to focus on each and every day.
The VIX is not the fear index. It is the expected move over the next year in the S&P 500.
There is a volatility index for the INDEXDJX:.DJI (Dow) with the symbol $VXD. The $VXD is not the fear index of the INDEXDJX:.DJI (Dow), it is the one year expected move of the Dow. Again, this is not pure speculation, we are getting these numbers from what the market believes. We are not smarter than the collective market and there and tens of billions of dollars agreeing on these expectations every day.
When indexes like the VIX or the $VXD are higher, it doesn’t mean there is more fear or risk to the downside. All it means is that over the course of the next year, the market is predicting a larger than average expected move. That sentence right there should make things a lot less scary for you :).
Now, you mentioned you wanted to know how far the INDEXDJX:.DJI (Dow) could move over the next year. No problem! What are the two things you need?
- Price of the Dow
- Price of the $VXD
From there, we run our simple calculation and find out in a matter of seconds what the market believes is the expected move.
Dow Price * (VXD price/100)*sqrt(days/365)
That’s it. You can have 100% confidence in that number. Seems a little easier than spending millions of dollars trying to calculate the potential price to earnings of all 30 components in the INDEXDJX:.DJI (Dow)…doesn’t it?