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This if for more advanced traders. If you need more help with this rule, please feel free to call us - 213-955-5858 ext 1.
The VIX is the single best indicator to use to guide you in timing your indices and equity trading. From the research created by Connors Research Group. TradingMarkets has more than 16 years of statistical price studies backing this.
First, let's quickly define the VIX. The Chicago Board Options Exchange SPX Volatility Index (VIX) reflects a market estimate of future volatility, based on the weighted average of the implied volatilities for a wide range of strikes. 1st & 2nd month expirations are used until 8 days from expiration, then the 2nd and 3rd month are used.
When markets are rising the VIX is usually low. When markets are declining the VIX usually rises. Extreme market sell-offs are associated with extreme VIX readings. Many web sites and analysts attempt to use static numbers for the VIX. This is wrong (in the early 2000's the prevalent wisdom was to buy the market when the VIX rose above 30 and to sell it when it went below 20. This worked for a short while until the VIX went under 20 in March 2003 (triggering the so called sell signal) and over the next two years, the market rose approximately 50% off its lows while the VIX never saw 30 again during that time!
The proper way to use the VIX is to look at where it is today relative to its 10 day simple moving average. The higher it is above the 10 day moving average, the greater the likelihood the market is oversold and a rally is near. On the opposite side, the lower it is below the 10 day moving average, the more the market is overbought and likely to move sideways-to-down in the near future.
The TradingMarkets 5% Rule. If you only follow one market sentiment indicator, it should be the TradingMarkets 5% Rule. The 5% rule states - Do not buy stocks (or the market) anytime the VIX is 5% below its moving average. Why? Because since 1989, the S&P 500 cash market has "lost" money on a net basis 5 days following the times the VIX has been 5% below its 10 day ma. That's right, in spite of the S&P 500 rising over 300% since 1989, it's lost money 5 days following the VIX closing 5% or more below its 10 day ma.
The TradingMarkets 5% Rule is also extremely powerful on the buy side. Since 1989, whenever the VIX has been 5% or more above its 10 day ma, the S&P 500 has achieved returns which are better than 2 1/2 to 1 compared to the average weekly returns of all weeks.
What does this mean for you? It means the potential edge lies in buying the market and stocks when the VIX is at least 5% above its 10 day ma, and to lock in gains (and also not buy) when the VIX is 5% or more below its 10 day ma.
You can find many more information on this on our website, in our indicators page, and in "How Markets Really Work" written by Larry Connors and Conor Sen.
Learn how to profit from current market volatility with the new CBOE VIX® Options.
Click here to attend a free 45-minute presentation this week with Larry Connors and learn how to trade the new CBOE VIX® Options.
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The Connors Group, Inc. ("Company") is not an investment advisory service, nor a registered investment advisor or broker-dealer and does not purport to tell or suggest which securities or currencies customers should buy or sell for themselves. The analysts and employees or affiliates of Company may hold positions in the stocks, currencies or industries discussed here. You understand and acknowledge that there is a very high degree of risk involved in trading securities and/or currencies. The Company, the authors, the publisher, and all affiliates of Company assume no responsibility or liability for your trading and investment results. Factual statements on the Company's website, or in its publications, are made as of the date stated and are subject to change without notice.
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HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING AND MAY NOT BE IMPACTED BY BROKERAGE AND OTHER SLIPPAGE FEES. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.
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