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.
