The word "volatility" is tossed around so often when talking about the stock market that it's hard to tell what it really means anymore.

This raises two questions: How does current volatility compare with "normal" market conditions? And what does extreme volatility mean over the long term for stock prices?

A common measure of market movement, the Chicago Board Options Exchange's volatility index, or VIX, indicates that stock prices might seem especially rocky because they're coming off an unusually low base. A look at how the stock market historically behaves after the VIX makes certain moves might offer some clues about strategies for investing in mutual funds.

For mutual fund investors, the perceived rise in volatility means a cautious exposure to mixed-asset funds might be a prudent approach until things settle down. But risk takers might interpret rising levels of volatility as signals of a market turnaround and a "buy" signal.

Either way, a close look at market volatility suggests investors haven't capitulated -- yet. That means most investors probably want to avoid the most volatile funds.

Described as an implied measure of expected volatility of the S&P 500, the VIX is an index of a number of out-of-the-money puts and calls on the S&P. Although the VIX jumped to a higher range during the middle months of 2007, it did so from a rather prolonged period of relatively benign volatility.

The following chart of monthly average VIX values shows that from the late summer of 2004 through June of 2007, the VIX spent most of its time at levels between 10 and 15. This includes November of 2006 when, at 10.82, the VIX reached the lowest average monthly level in the 18 years covered on the chart.

Click here for larger image.

Because it has lifted off such a low base, the VIX's move in recent months to levels modestly above its 18-year average of 18.99 seem more extreme than it might otherwise appear. Moreover, the Dow Jones Industrial Average spent time in the neighborhood of 14000 during 2007. At that level, moves of 0.7% in the Dow became "triple-digit days." Four years ago, when the Dow fluctuated in the 8000 range, it took a move of 1.25% to rate as a triple-digit day.

The VIX's recent range of monthly averages in the low- to mid-20s roughly corresponds with the period from late 1999 through the autumn 2001, when the stock market ascended to its tech-bubble crest and then began its subsequent bear-market slide.

Because the VIX is composed of put as well as call options, it will rise when fear grips the market and worried investors rush into puts as insurance against severe downturns. Extremely pessimistic periods, when accumulation of puts results in sharp rises in the VIX, often mark points of capitulation when pessimism reaches an apogee and the market frequently turns higher because everyone with an inclination to sell has already done so.

Every major increase in the monthly average VIX has corresponded with a subsequent advance in stock prices, although some were ephemeral moves punctuated by sharp subsequent reversals.

A crest in the monthly average VIX just shy of 30 in October of 1990 coincided with the end of a dip in the S&P 500 that turned into a steady rise. That upward trend eventually tilted even higher into the big middle years of the bull market of the 1990s.

The bull market of the 1990s stalled briefly after the Asian financial crisis in 1997. But a resumption of uptrend that began in October 1997 was confirmed by a rise in the monthly average VIX the following month.

The subsequent advance was truncated a year later, but a sharp peak in the VIX in September of 1998 to its highest-ever monthly average coincided with the beginning of the market's two-year move to the top of the tech-stock bubble.

An increase in the VIX monthly average in September of 2001 coincided with the start of a three-month bounce in the S&P during the 2000-2002 bear market. Then, the volatility gauge hit its second-highest monthly average in September 2002 to signal the beginning of the bull market that prevailed until last year.

Another rise to a monthly average of 32.22 in the VIX during February of 2003 marked the beginning of a strong advancing phase of the five-year climb.

An advance of the VIX in the low- to mid-30s in recent sessions might prompt some investors to jump back into the market. The gauge's ascent into "market reversal" territory coupled with the Fed's recent aggressive monetary moves might convince them that the market is set to rise.

Volatile funds, such as those in the top section of the table below, would be prospects to lead an market advance.

The top list is composed of funds with TheStreet.com Ratings grades in the "A" and "B" ranges with the highest three-year standard deviations (a statistical measure of how closely their growth rates adhere to trends, with higher values designating greater volatility).

Trackers of the VIX might feel comfortable waiting for a surge in the gauge's monthly average to a level of 30 or more before gaining confidence that the current slump has run its course. For them, the low-volatility stocks in the accompanying table would be worth considering as low-risk parking places.

The funds -- all hybrids containing equities and fixed-income investments -- are graded in the "B" range by TheStreet.com Ratings. They represent the lowest volatility "buy" recommended equity/hybrid open-end mutual funds in our database.
HIGHS AND LOWS OF VOLATILITY
NAME, TICKER & TheStreet.com RATINGS GRADE OBJECTIVE 12-MO. TOTAL RET'N (%) 3-YR. ANN'L RET'N (%) 3-YR. ANN'L STD. DEV'N (%) SALES CHARGE TYPE
HIGH VOLATILITY FUNDS
Allianz NACM Pacific Rim A (PPRAX) B- Non-US Equity 21.85 26.13 41.49 Front Load
Dreyfus Premier Greater China A (DPCAX) B Non-US Equity 61.85 46.29 24.14 Front Load
T. Rowe Price Latin America (PRLAX) B- Non-US Equity 48.93 53.34 23.47 No Load
Columbia Greater China A (NGCAX) B Non-US Equity 59.07 43.25 22.68 Front Load
BlackRock Natural Resource Inv A (MDGRX) B- Sector - Energy/Natural Res 42.62 32.21 21.66 Front Load
US Global Inv China Region Opport (USCOX) A- Global Equity 53.29 35.86 21.61 No Load
Dreyfus Premier Natural Resources A (DNLAX) B Sector - Energy/Natural Res 43.76 29.50 21.42 Front Load
GMO Emerging Countries Fund III (GMCEX) B- Emerging Market Equity 19.23 28.16 21.41 No Load
CGM Focus Fund (CGMFX) B+ Aggressive Growth 79.92 37.38 20.93 No Load
Franklin Natural Resources A (FRNRX) B Sector - Energy/Natural Res 38.87 29.69 20.91 Front Load
LOW VOLATILITY FUNDS
GE Conservative Allocation (GECAX) B Asset Allocation - Domestic 8.43 7.75 3.77 No Load
GE Conservative Strategy Fund (GCSTX) B Asset Allocation - Domestic 8.46 7.67 3.80 No Load
James Advantage Bal Goldn Rainbow A (GLRBX) B- Balanced - Domestic 8.61 8.30 4.01 No Load
TIAA-CREF Lifecycle 2010 Retire (TCLEX) B Asset Allocation - Domestic 9.20 7.26 4.30 No Load
Manning & Napier Pro-Blend Mod Term (EXBAX) B Asset Allocation - Domestic 6.34 8.85 4.39 No Load
State Farm Balanced Fund (STFBX) B+ Balanced - Domestic 11.44 9.29 4.45 No Load
American Century LStrong 2015 Inv (ARFIX) B Asset Allocation - Domestic 8.50 7.88 4.50 No Load
Vanguard Target Retirement 2015 Fd (VTXVX) B- Asset Allocation - Domestic 7.55 7.94 4.66 No Load
LKCM Balanced Fd (LKBAX) B- Balanced - Domestic 8.25 8.42 4.79 No Load
Oakmark Equity and Income II (OARBX) B Balanced - Domestic 11.59 10.12 4.81 No Load
S&P 500 Composite Total Return 5.49 8.61 7.74
Data as of 12/31/2007.
Source: TheStreet.com Ratings
Richard Widows is a financial analyst for TheStreet.com Ratings. Earlier, Widows was senior product manager for quantitative analytics at Thomson Financial. After receiving an M.B.A. from Santa Clara University in California, his career included development of investment information systems at data firms, including the Lipper division of Reuters. His international experience includes assignments in the U.K. and East Asia.