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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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| What is the VIX? |
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The VIX is a measurement of the implied volatility of
the at the money OEX Index Options. |
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| Markets Rise When |
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High VIX readings usually happen after
markets go through sharp sell offs and when fear is rampant. During these
times, sharp upside reversals often occur.
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| Markets Fall When |
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Low VIX readings usually occur when the
market rises. This tends to show that complacency exists in the
minds of most market participants and a sell off is near.
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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. |
