|
PureBytes Links
Trading Reference Links
|
I received many e-mails about the VIX setup mentioned last week. Jim O.
thought it was an OK idea to post this expanded explanation of the
indicator and another of its setups. I'm quoting from Larry Connors book
with his permission. As the editor of the book I had the chapter sitting
on my hard drive and have had only to cut and paste.
"Connors on Advanced Trading Strategies"
Chapter 2
Connors VIX Reversals
In 1994, when Blake Hayward and I [Larry] wrote Investment Secrets of a
Hedge Fund Manager, we included a chapter entitled, "New Markets, New
Indicators." Among the strategies mentioned in that chapter was one which
incorporated the VIX indicator. I mentioned that up to that point markets
made very short-term tops when the VIX dropped under 11 percent and very
short-term bottoms when the VIX traded above 15 percent. Because the
indicator was so new, I felt it was too soon to blindly fix upon those
levels, but the concept certainly had promise.
Since that time, and especially after 1995, the normal daily trading range
for the VIX has greatly increased. In this chapter, I will show you how I
have adjusted the parameters of the indicator to identify one- to three-day
market tops and bottoms. I have also included more than four years of test
results. We will also look at how to apply the readings to trade the S&P's
and the stock market.
THE VIX
j
The VIX (CBOE, OEX, Volatility Index) reflects a market consensus estimate
of future volatility based on "at-the-money" quotes of OEX index options.
Periods of low volatility (a low VIX reading) basically reflect a quiet,
rising market, whereas periods of high volatility (a high VIX reading) are
associated with sharp market sell-offs.
The VIX is used as a contrary indicator. The higher its reading (and hence
the more fear in the market), the more likely the market is reaching a
short-term bottom, and the lower the reading, the more likely the market is
reaching a short-term top. In my opinion, due to the increasingly
speculative role that OEX options have assumed, the significance and the
reliability of the VIX as a market timing indicator have greatly increased
over the past few years.
Until now, most traders have used predetermined static bands (as I did in
1994) to identify what is a "high" reading and what is a "low" reading.
Although this works, one never knows if those bands are truly reflective of
today's market or if they really only reflect how markets reacted in the
past. I endeavored to create a way to look at the VIX only within the
context of its very recent price action.
CONNORS VIX REVERSAL III
This is the third VIX Reversal strategy I follow. It was co-created by a
member of my research staff, Dave Landry. Dave, who is also a CTA, is in my
opinion, a top researcher. More importantly, he very much understands
underlying market principles.
As many of you are aware, volatility is mean reverting. This means periods
of high volatility are likely to revert back to their normal levels and
periods of low volatility also revert back to their normal levels. I have
found that this concept is an inherent feature of the VIX. Dave and I found
that by applying the reversion to the mean principle, we could predict S&P
behavior. We found that whenever the VIX closed 10 percent above or below
its 10-day moving average, it had a tendency to revert back to its mean. At
the same time stock market prices also reversed.
Here are the rules of the "Connors VIX Reversal III" (CVR III):
FOR BUYS
1. Today, the low of the VIX must be above its 10-day moving average.
2. Today, the VIX must close at least 10 percent above its 10-day moving
average.
3. If rules 1 and 2 are met, buy the market on the close.
4. Exit (on the close) the day the VIX trades (intraday) below yesterday's
10-day moving average (reversion to the mean).
FOR SELLS
1. Today, the high of the VIX must be below its 10-day moving average.<D%0>
2. Today, the VIX must close at least 10 percent below its 10-day moving
average.
3. If rules 1 and 2 are met, sell on the close.
4. Exit (on the close) the day the VIX trades (intraday) above yesterday's
10-day moving average (reversion to the mean).
Four year S&P Futures result 1/01/93 through 10/1/97
75 trades 54 winners 21 losers 72% profitable (78% on the long side
- 65% on short)
[I could not post the complete tabular results from the book via e-mail -
Bill]
SUMMARY
As you can see, the results are solid both to the long and short side. The
average profit per trade is excellent and the percent profitable is also
quite strong. Finally, as always, a protective stop helps avoid potentially
large drawdowns.
In my opinion, and as you can see from the three CVR strategies, the VIX is
a superior vehicle to the put/call ratio for using options to predict
market direction. By combining the three reversal methods, you will be able
to identify reversals in the stock market on a more efficient basis.
**********************************
End of Quote from COATS.
The book has three CVR setups and many other original, concrete, tradable
methods.
Larry comes at the markets as a trader first and foremost. His setups are
unconventional and profitable.
(One of his research assistants, trading one DOW future using only the Vix
Reversals, made more income from the trade than he did from his salary.)
I trade them in combination with one another or with one other setup from
the book. It's my biggest and most consistent winner.
I neither work for - nor do publicity for - Larry. I am posting this as a
service to the traders on the list, not as an advert for the book. However
if you want to see more, the site is
http:\\www.mgordonpub.com.
|