The Fear Trap: How the VIX Turns Traders into Victims of Their Own Emotions

Increased market volatility means stocks are falling, right? Wrong.

I admit that when the VIX – the Cboe Volatility Index – rises, I expect a drop in the stock market. Judging by investors’ anxious reaction following the VIX spike after President Donald Trump’s announcement of major tariffs last month, I’m clearly not the only one.

The VIX, a gauge of expected 30-day volatility in the S&P 500, nearly tripled during the four trading days after the White House’s April 2 statement. On April 8, it closed at 52 – the third-highest level in its history since its creation in 1990, surpassed only during the 2008 financial crisis and the Covid pandemic.

As we now know, investors’ fear of an impending market crash was unfounded. The market bottomed out on April 8 – the same day the VIX peaked. Since then, through Monday, the S&P 500 has risen by 13% – a significant gain in a short time. The VIX did indeed signal higher-than-usual volatility – meaning that stock prices would move more sharply than normal. It just turned out that these big moves were gains, not losses – contrary to many investors’ expectations.

That shouldn’t be surprising. Volatility measures the degree of price change, not the direction.
High volatility can mean big price increases or declines, just as low volatility implies smaller movements in either direction. So when the VIX is elevated, it’s entirely possible for large gains to follow—just as much as sharp losses—something the market reminded investors of in recent weeks.

Knowing this, I’m still not entirely sure why I continue to associate a rising VIX with a market drop. Maybe I’m subconsciously influenced by its ominous nickname—“the fear index,” a reference to the panic that grips investors when the VIX spikes.

That negative association is largely unfounded. While the VIX is a good indicator of short-term volatility, it’s not a reliable signal of market direction. Since 1990, the VIX has shown a strong correlation with future 30-day volatility of the S&P 500, measured by annualized standard deviation (0.69). But it has almost no correlation with the S&P 500’s price performance over the next 30 days (0.1).

In fact, using the VIX as an investment guide often leads to losses, because the market typically rises regardless of the index’s level. I ranked daily VIX readings from 1990 to today in descending order and divided them into quintiles. In the highest quintile—where the VIX is most elevated—the S&P 500 rose 68% of the time over the following 30 days. That percentage was nearly identical for the lowest quintile, as well as the other three.

Given the lack of connection between the VIX and market direction, a more suitable nickname might be “the uncertainty index.” Uncertainty is usually the root of volatility, and like volatility, it doesn’t imply any specific outcome. Sometimes uncertainty ends badly—like during the financial crisis—and sometimes it passes without major consequences—like after the U.S. debt ceiling scare in 2011. Most often, it just lingers in the background while companies continue to grow their earnings—so the market usually trends upward, regardless of the VIX.

It’s important, however, to distinguish between the level of the VIX and changes in it. A rising VIX is strongly negatively correlated with a falling market, and vice versa (–0.68 when comparing simultaneous 30-day changes in the VIX and S&P 500). But investors can’t predict where the VIX is heading any more reliably than they can forecast the market itself. And when the VIX is already elevated, the market downturn has often already happened.

That’s exactly what happened last month. The S&P 500 plunged while the VIX surged. By the time the VIX reached alarmingly high levels, the market had already bottomed. That doesn’t mean the sudden turnaround was inevitable, of course, but VIX history suggests the odds favored a rebound.

So where are we now? The VIX sits around 24—less than half its level on April 8 but still above its long-term average of about 19. That likely means more volatility ahead—a view increasingly shared by corporate executives, who say ongoing uncertainty around tariffs is complicating planning and forecasting.

It’s easy to see why the VIX is projecting bigger-than-usual market swings. Trump’s sweeping tariffs represent a massive risk with uncertain and potentially significant consequences. If they ultimately lead to deals that lower trade barriers for U.S. companies, the market will likely celebrate. But if a prolonged trade war raises the cost of doing business, stocks won’t be so happy.

That uncertainty may keep the VIX higher than anyone would like—for a while longer. Just don’t automatically assume it means the market is heading down.