VIX Market Timing

The Vix market timing module is included with OT Pairs, and is available via in-app purchase for OddsTrader, OT Trend, OT Fibonacci, OT Pivots and Gann 9.

Using the VIX (Volatility Index developed by the CBOE in 1993) as a market timing tool has a long history and has many variations. It's based on the observation that high VIX readings usually coincide with market bottoms, while low readings signal market tops.

The VIX falls within the category of so-called “contrarian” indicators. It tends to move  between well defined ranges, which change over time. However, whenever the index reaches the top or bottom of that range, it is a reliable signal that a change in trend for the market is imminent.

When investors are running scared or feel a high degree of uncertainty about the future trend of the market, they tend to pile into put options bidding up their premium, which coincides with spikes in the VIX index. The opposite is true for bullish periods, when there is less fear, and the investing public feels less need to buy puts. Such periods coincide with lower VIX readings suggesting complacency.

By monitoring the behavior of the VIX, and using it as a gauge of investment sentiment, alert investors can position themselves ahead of the crowd and anticipate when market turns are likely to occur.

You can follow VIX futures here.

There are several ways of achieving this. The first one is to look at the actual VIX readings and try to determine when it is about to peak or bottom. 

For user convenience, the module automatically highlights the high/low VIX range for the selected time period. The problem with this approach is that, although in the long run the index moves within a well-defined range, there is no telling in advance at precisely what level the reversal will take place. 

The other option is to apply different technical indicators to the VIX in order to determine when it’s reaching overbought/oversold levels. Systems in this group are centered around the use of the RSI, moving averages of varying length, MACD, DMI, Bollinger bands, Williams %R, etc.

For a list of books on the subject, check out Larry Connors' writings.

We are introducing a new approach.  We apply a pivot moving average (pma) to both the VIX and the SPX, and monitor whether the indices cross/trade above/below the pma. 

The indices can trade either on opposite sides or on the same side of the average. 

Under normal conditions, one would expect the indices to trade on the opposite side of the average. When they trade on the same side of the pma, that usually is an early warning signal that the trend is about to change. 

From a practical point of view, however, we’ve noticed that rushing to react merely because the indices are suddenly trading on the same side of the average can lead to frequent whipsaws. Therefore, we’ve included two signal lines in our module. 

The signal line at the bottom of the top chart turns green when VIX is trading below and SPX is trading above the pma. The line turns red when the opposite occurs, i.e. when VIX trades above and SPX trades below the pma. If the indices trade on the same side of the pma, the current signal remains in effect until reversed.

The signal line in the bottom  (second) chart turns yellow when the indices trade on the same side of the pma. As explained above, this could be an early warning signal that the trend is about to change, but could lead to frequent whipsaws as well. Also note that intraday spikes in volatility (e.g. FOMC announcements) can skew the pma readings. Therefore, user discretion is advised.

This approach has several advantages.

First, the pma for the day is fixed (it won't change during the day), and is clearly displayed on the chart (next to the symbol cells). This gives users the ability to plan their trades ahead of time, to place alerts for predetermined index levels, etc. The values turn green or red depending on whether the pma is below or above the SPX. The opposite is true for the VIX pma readings.

Second, users are not limited to the SPX/VIX pair (^GSPC/^VIX), but can enter other pairs of their choice, e.g. ^OEX/^VIX, SPY/^VIX, DIA/^VIX, QQQ/^QQV, IWM/^VIX,  SPY/AGG, etc.  Please note, though, that the results for SPX, SPY and OEX may differ due to the fact that only SPY reports real open prices.
 
Currently  the CBOE is tracking more than 20 volatility indices. Once Yahoo finance starts reporting historical data for all of them, users will be able to monitor many more pairs.

Third, if you input a random pair of stocks, the top signal line will show when  stock A outperforms stock B on a relative strength basis.

Now let’s proceed with a brief case study in order to evaluate the effectiveness of such an approach.

The SPX/VIX pair gave a sell signal for the SPX on Monday, September 23^rd, 2013 preceding a 50+ SPX points drop).  The QQQ/QQV (QQQ/VIX) pair gave a sell signal on Friday, September 27^th. Then both pairs remained on a sell signal despite the spike up on Tuesday,October 1^st , and the fact that the Qs made a new high. Both signals were reversed on October 10th, 2013, signaling a 90+ SPX points upswing.

In summary, the new VIX market timing system provides users with deeper insight into the markets that cannot be achieved by traditional TA tools.  Armed with this powerful new market timing tool, smartphone users can use it either as a standalone signal generating system, or as an instrument to support their other analytical tools.

   

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