Things to Know About Volatility
and Why VIX Signals Work | ||||||||||
The VIX Measures
FEAR High VIX readings mean that fear is also high, whereas
low VIX readings mean that fear is low. Backtesting various VIX reversal
signals has proven that the VIX can be used to predict market direction about 60
to 70% of the time, the more VIX signals the better. What this means is that
when the VIX is at an extreme (meaning everyone thinks the market will continue
in that direction), a top or bottom is usually in place and what usually happens
is the market reverses in the opposite direction.
Volatility (VIX) Tends
to Trend
This means that if the VIX rises today, it has a higher than average chance of rising tomorrow. This is even more significant at market extremes and right before market reversals.
The VIX is
Dynamic What this means is that you can not predict market
direction simply by the level of the VIX. In the past, many traders simply
bought the market when the VIX goes above 30 and sold the market when it traded
down to 20. Because the VIX and volatility is constantly changing this
strategy simply doesn't work. Now, more than ever, it is the relative level
of the VIX that is important, not the absolute value.
Volatility is Mean
Reverting
This means that periods of high volatility will be followed by periods of low volatility. This was academically proven over 50 years ago and is one of many market truths. This is important because when the VIX has a low reading and begins to revert to its mean, it is also accompanied by a market that begins to sell off. It is the same for when the VIX has a high reading and changes direction, this typically is accompanied by a market that begins to rally. VIX Reversal Signals |
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There have been many books written about
the VIX and signals have been developed that help traders pinpoint when the
market is most likely to reverse. What all of these signals have in common is
that they use various means to determine when the VIX is at an extreme and
either reversing or about to reverse. While historically these individual VIX
Signals have worked 60 to 70% of the time, that is no longer the case in today's
market. Why is this? Because EVERYBODY knows about them and is watching them.
Whenever a system or strategy becomes known to too many people, it often fails
to live up to the results it once had. However, that being said, when multiple
VIX Signal are generated, there is still a very high probability of the market
reversing.
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Tuesday, May 1, 2012
Things to Know About Volatility and Why VIX Signals Work
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Helpful Information.... thank you sir
ReplyDeleteDefinitely agree with what you stated. Your explanation was certainly the easiest to understand. I tell you, I usually get irked when folks discuss issues that they plainly do not know about. You managed to hit the nail right on the head and explained out everything without complication. Maybe, people can take a signal. Will likely be back to get more. commodity trail
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