Trend Trading with the VIX
- Statistically Valid
- Ease Of Use
- Simple To Master
We know that the trend is our friend. We proved it with our Mid-Point trading strategy.
But what if we want to be more than "just friends?" What if we want the trend to drop her drawers and dance naked on our bed? Today, I would like to introduce the VIX. A potent and sometimes powerful "love potion" that might just work magic in your favor.
Furthermore, I would like to talk about trading strategy automation. How we can use modern tools to make life, and trading a little easier.
A Workable Trading Strategy
Today’s article is a trading strategy session. A trading system for the Emini SP500 futures contract. Complete with exact entry and exit rules with accompanying statistics.
This trading strategy is a follow-up article to ‘Intraday Trend Trading: Is the Trend Really Your Friend?‘ If you did not read that article, shame on you. That article serves as the starting point, and this article serves as the follow-up. If you continue, without reading and understanding the original concept, then much of this will seem very confusing.
In that article, I defined a broad market bias in the stock index futures market.
Essentially, I presented statistical evidence that trading in the direction of the primary trend is a valid approach. This article is going to take that clearly defined market bias, and improve upon it. Without curve fitting or over optimization.
At the end of this article, you will be able to deploy and (hopefully) profit.
Introducing the VIX or Volatility Index
Most people have no idea what is the VIX. The VIX is a volatility calculation of the options contracts that are traded at the CBOE, or Chicago Board Options Exchange.
The VIX is recalculated every 15 seconds throughout the trading day. The VIX is a standard feature on nearly all modern trading platforms.
What exactly is the VIX? In a nutshell, it is a volatility calculation of the nearest options contracts prices for the stocks contained within the SP500. The VIX serves as a quick and dirty way for market participants to judge whether stock options prices are moving aggressively, quickly, or slowly.
The VIX also serves as a proxy for stock market direction. Generally speaking, when the VIX is UP, then the stock market is DOWN. And when the VIX is DOWN, the stock market is UP. I have included a visual below.
At first glance, the inverse relationship of the VIX appears to be 100% constant. To the casual observer, it looks like a seesaw. When the stock market swings lower, then the VIX swings higher, etc.
However, this is not always true. In fact, the relationship is valid only about 80% of the time.
The VIX is not a perfect predictor of future stock market price direction or stock options pricing volatility. However, in the land of the blind, the one-eyed man is king. So we are going to attempt to use this somewhat confusing, arcane, obfuscated and imperfect measurement tool as a filter for our trading system. We are not interested in the daily movements. We are only interested in “shock” movements of the VIX. Specifically, when the VIX crashes lower by < -4% intraday.
When the VIX crashes lower by < -4% intraday, we are seeing two things happening:
- Stock prices are moving higher
- Options volatility is decreasing
The ‘secret sauce’ is the combination of both. The rapid movement of both, moving in the same direction.
Let’s now move into the strategy rules.
Trading Strategy Rules
- Wait 2 hours.
- If the intraday VIX is down < -4%.
- Calculate the middle point of the intraday range.
- If a 5-minute bar crosses above the mid-point, then buy at the market.
- Exit the trade for whatever profit at the end of the trading day.
- Exit the trade for a loss if a 5-minute bar crosses below the mid-point of the day.
Trading Strategy Results: Stock Index Futures
Results for the Emini SP500 are as follows:
- Profit Factor 1.72
- Total Trades 441
- Ave Trade $65
- Max Drawdown $2,750
Results for the Emini Russell 2000 are as follows:
- Profit Factor 1.80
- Total Trades 468
- Ave Trade $51
- Max Drawdown $1,880
As you can see, the results are quite robust. However, this is just the tip of the iceberg. The truth of the matter is that I have only touched the surface of this concept. We can dig even deeper, and show yet more profitable trading strategies. With even more robust equity curves. That are nearly 100% accurate and are so compelling that your mouth with water with anticipation.
But I will not give away the entire store. Rather, I hope to inspire you. To get off your ass and start programming these basic concepts. To take control of your own destiny. Build your own trading models that are deeply rooted in science, common sense and valid theory. To veer away from the incredibly ridiculous world of magical trading indicators.
Trading System ON/OFF Switch
One thing that drives me crazy about trading system vendors, they never talk about when to turn a trading system OFF. All things change, especially financial markets. What is great theory today, will soon enough be a terrible theory. Will drain your account to nothing. So you have to have a method that turns a trading system off.
There are so many opinions of when to turn a trading system OFF. But I have discovered that by keeping things simple, and not overcomplicating, we can achieve a pretty good result. My own method is sort of like using a hammer in a sword fight. To put it plainly, I use a 100 period moving average of the equity curve. It’s not perfect, but it works for me.
Once the equity curve breaks the 100-period moving average, then it’s time to shut it down. On the above charts, you will see a blue line which represents a 100-period moving average of the equity curve. During periods of low volatility and underperformance, the system will shut down. But when volatility begins to rear its fearsome head, the system starts kicking off profits, and the equity curve shoots higher (hopefully).
The Importance of Automation
With the above strategy, a signal will fire off a trade only 2 or 3 times per month. However, some months might fire off 15 trades. The truth is that nobody really knows when plunging options volatility pricing will occur. The VIX resets every 15 seconds. So you have to have a regime that is constantly waiting for this situation.
Automated trading solves this problem.
A Stable of Automated Strategies
Finding these bits and pieces of an exploitable market edge are not easy. You need to think in terms of running a casino. Your strategies are just little slot machines, all lined up, waiting for someone to insert their money. To take the opposite side of your trade.
Since markets are always in a state of change, you need trading strategies that work across a broad spectrum of environments. You need strategies that exploit not just the stock market, but also currencies, and commodities. Use modern computing to find only the choicest, most juicy trading scenarios.
Thanks for reading today. A bit of a long article. With a technical aspect, which requires clarity in explaining a complicated, multifaceted scenario. These sorts of topics, I am not very good. I apologize if I confused you.
If you need any help with strategy development or just an opinion. Please do not hesitate to contact me. I can program most any idea in a few minutes.
I will leave you with a breadcrumb, that might lead to the bakery. In the above strategy, we explored the stock index futures contracts. But these stock index futures are just groups of stocks. Try this strategy on subsector ETF’s, or individual stocks. You might find something truly amazing.
Thanks again for reading. And don’t forget to comment below.