Market Timing Using The VIX Workshop
Larry Connors
Good afternoon, everyone. I want to welcome you to our first weekly TradersTalk
session. Over the next few weeks Dave Landry will be here, Tony Saliba, and
others will be teaching you some of their favorite strategies.
bbehzadi
Hi, Larry.
Larry Connors
As far as protocol goes, for the next 20 to 30 minutes, I’ll be teaching you
some of the basics behind the VIX, and two specific VIX strategies, then we’ll
open this up for some questions. If you have any questions, send them to
tradertalk@tradingmarkets.com, and I’ll select the questions that apply to the
majority of you. Those questions I don’t answer here in the session, I’ll send
you a reply directly.
Larry Connors
To start, let’s look at what the VIX is and why, in my opinion, it’s the best
market-timing indicator available for short-term traders today. The VIX is
simply a measurement of the implied volatility of the at-the-money OEX Index
Options.
Larry Connors
High VIX readings usually occur after markets experience sharp sell-offs.
wint
Is there a way to link VIX signals with low-volatility signals on individual
stocks?
Larry Connors
During these times, fear is rampant and sharp reversals to the upside tend to
occur.
Larry Connors
Low VIX readings, as we are seeing now, usually occur when the market rises.
This is a signal that complacency is in the market and a market sell-off is
near.
Larry Connors
In an effort to give you a full base of understanding and to help grow your
learning of the VIX, let me give you four principles that will guide you as to
why the VIX signals work.
Larry Connors
1. All volatility is mean reverting. This simply means that periods of low
volatility will be followed by periods of high volatility, and vise-versa. The
academic world proved this nearly 50 years ago, and it’s one of their few
truisms of market behavior.
laurendeau
who calculates the value of the VIX?
Larry Connors
The reason this is important is that when the VIX has a high reading and begins
to revert to its mean, it’s also accompanied by a market that begins to rally.
Same thing for low VIX readings — when it begins reverting to its mean, it’s
many times accompanied by market sell-offs. Keep that in mind whenever you’re
looking at a VIX chart in the future.
Larry Connors
2. Volatility is auto-correlated. That means if the VIX rises today, it has a
better-than-even chance of rising tomorrow. THIS IS MOST SIGNIFICANT AT MARKET
EXTREMES AND RIGHT BEFORE REVERSALS.
Larry Connors
3. This is the one that gets most traders on Wall Street messed up, and if you
only learn one thing from this session, this is the most important thing to
learn. The VIX is dynamic, not static, simply saying that you buy the market
when the VIX goes above 30 and sell the market when it trades around 20 is sheer
B.S. The press over the past couple of years has done a wonderful job of
engraining this into traders’ heads, but it can be no further from the truth.
Blindly entering the market because the VIX reaches some pre-determined level
will eventually get you killed.
mxreturn
One thing that I have found extremely useful is to look at weekly charts of the
VIX compared to weekly charts of the S&P.
Larry Connors
4. As mentioned before, the VIX measures fear. High VIX means that fear is high,
low VIX readings mean that fear is low. History has proven, and the CVR signals
have statistically proven, that approximately 2 out of 3 times, when these
market expectations occur, a top or bottom is in place and we’re going to look
to fade these expectations as we know we will be right approximately 65% of the
time.
Larry Connors
I’m now going to teach you two of my 10 CVR strategies. Both of these strategies
can be found nightly on our Market Bias page. Also, all the strategies can be
found in my book Trading
Connors’ VIX Reversals and in my nightly service found on TradingSubscriptions.com.
(Why do I feel like Landry right now, shamelessly plugging my stuff?)
Larry Connors
For this session, please click
on this link to help guide you on the two
strategies I’m about to teach you.
You’ll need to type this in to get access to it. I’ll pause here for a minute so
you can go to that page.
Larry Connors
The 10 CVR signals as a whole over the past nine years have correctly predicted
two- to three-day market direction for the S&Ps approximately 65% of the
time. The CVR 3 and the CVR 7 have correctly predicted direction nearly 70%.
Today, let’s first look at the CVR 1 signal, which is the most basic of signals,
and then we’ll look at the CVR 3 which is one of my favorites.
john gentis
Are there any tools you use that help you attach a framework to a VIX chart? For
example, MACD, how VIX relates to VXN. How would you describe the 11/29 VIX as
different from 12/14?
Larry Connors
The rules for the CVR 1 are simple. For market buys, we are looking for the VIX
to make a 5-day high and close under its open. For sells, we are looking for the
VIX to make a 5-period low and close above its open.
Larry Connors
Let’s talk conceptually about what is going on here. First, a 5-period high or
low for the VIX tells us that the market on a short-term basis may be reaching
some extreme. By waiting for it (for buy signals) to make a 5-period high and
then at the same time closing below its open (remember Rule #2 – Volatility is
auto-correlated), we are finding a market that may be experiencing a sentiment
extreme and has a higher-than-average probability of reversing for the next 2 to
3 days.
Larry Connors
Take a look at some of the CVR 1 buy signals that occurred through the month of
December and helped us open up this year. As you can see, it did a good job of
identifying swing lows throughout the month.
Larry Connors
The CVR 1 correctly predicts market direction approximately 59% of the time (one
of the lowest of all the CVR signals), but I’m showing it to you more
importantly for two reasons. One, for educational purposes to get you to better
understand conceptually what is happening, and two, for the fact that the CVR 1
signal, when it’s combined with the CVR 3 signal (and many other signals) tends
to increase the percentage of the time that the signal is correct.
Larry Connors
I see some of you are sending in questions about how to trade these signals. I
will cover that after we talk about the CVR 1 and 3 signals.
Larry Connors
Now, let’s move on to the CVR 3 signal and then we’ll talk about entry and exit.
The CVR 3 signal was co-created by me with Dave Landry. What we found is that
when the VIX moved 10% away from its 10-day moving average, it identified a
market that had been “stretched too far” and was likely to reverse. In
fact, over the last nine years, it has correctly predicted a two- to three-day
reversal better than 68% of the time.
billbarack
CVR 3 moves 10% from its 10-day MA. Is this on close or on high or low?
daysales
Larry, I understand you have a new book out on the VIX. Can you say something
about the new signals that are covered there?
Larry Connors
The rules for the CVR 3 are as follows: For Buys: 1) Today, the low of the VIX
must be above its 10-day moving average. 2) Today, the VIX must close at least
10% above its 10-day moving average. 3) If rules 1 and 2 are met, buy the market
on the close. 4) Exit (on the close) the day the VIX trades (intraday) below
yesterday’s 10-day moving average (reversion to the man). Or exit within two to
four days.
mickeymfa
What about 11/29/01 on the chart? Isn’t this a CVR 1 BUY signal, too? Or
shouldn’t it be because it’s not showing?
Larry Connors
For sells: 1) Today the high of the VIX must be below its10-day moving average.
2) Today the VIX must close at least 10% below its 10-day moving average. 3) If
rules 1 and 2 are met, sell on the close. 4) Exit (on the close) the day the VIX
trades (intraday) above yesterday’s 10-day moving average (reversion to the
mean). Or exit within 2 to 4 days.
Larry Connors
Again, let’s look at this conceptually. For the VIX to move 10% away from its
moving average, the market must have gone through some extreme, one-way move. As
we all know, the short-term moves are nearly always unsustainable, and the best
reversals come from them. We have found that the best way to measure these
extremes is with the CVR 3. On average, a CVR 3 signal occurs about once every 2
1/2 weeks, and we look to exit within a 2 to 4-day period of time.
billbarack
Are the prediction statistics for all the CVR signals % correct listed in your
book. And combination signals statistics?
Larry Connors
Now I want to cover one final thing before talking about which markets to trade
and entry and exit. The CVR signals perform even better when you have multiple
signals all pointed in the same direction. If you take the signals from our
Market Bias page, you’ll want to see at least 2 CVR signals pointing in the same
direction. IF you take the signals from my trading service, the ideal time is to
wait for 3 or more signals pointing in the same direction.
Larry Connors
Also, many of you have your own market-timing methods, some which I’m sure are
quite good. CVR signals combined with your own internal signals will give
further confirmation that your signals have an edge and increases the odds that
your trade will be successful.
billbarack
How many signals do you publish on your trading system?
JBL
Can a similar analysis be used on individual stocks using HV or IV?
Larry Connors
One caveat to this whole thing. No matter how sure you are that the market is
going to move in one direction, you need to make sure you use protective stops
and proper position size to manage the position. Even if you have a methodology
that’s right 70% of the time, it’s more important to remember that it’s wrong
30% of the time. The gains take care of themselves, it’s how you manage that 30%
wrong that will ultimately decide how successful you are with your trading.
Larry Connors
Let’s now talk about which markets to trade and how to enter positions. The
majority of my testing (and real-world results) with the CVR signals have been
with the S&P futures. This means that the best way to replicate the results
that have occurred is to trade S&P futures (E-minis) or SPDRs. For the
S&P futures, had you traded one contract for every CVR signal since 1993,
you would have earned approximately $1.8 million since this past summer. THERE
IS NO GUARANTEE THIS WILL HAPPEN AGAIN. But this should give you an idea of the
cumulative effects of the CVR signals from 1993 up until recently.
Larry Connors
With the SPDRs, you’ll essentially be looking at the same results
(percentage-wise).
billbarack
And that percentage is what?
Larry Connors
For those of you who don’t want to trade SPDRs or trade S&P futures, you
should look at the Market Bias page and the CVR signals as to guide you what the
likely market direction will be for the next couple of days for the market. One
of the things we have continuously preached on the site from Day 1 (in spite of
the fact that it wasn’t in vogue in 1999) was that we need to trade both sides
of the market to fully take advantage of them. Too many methodologies out there
are “bull market only” methodologies (or “bear market only”)
and all these guys got killed when the market turned on them. If you’re not
trading both sides of the market, you should strongly consider doing so. Dave
Landry (there’s that name again) wrote an excellent article that’s archived in
our education section on how to short stocks, and you may want to look at it.
Also, one of the advantages of trading SPDRs is that they do not require an up-tick
so you can short them immediately without worrying about violating the up-tick
rule.
mickeymfa
And apart from one missing CVR 1 buy signal on that chart, what about the CVR 1
sell signals? They are not shown either right ?
Larry Connors
Probably the biggest edge with the VIX signals occurs in the options market, and
I’ll be the first to say after trading the CVR signals for nearly 6 years, I
haven’t come anywhere close to taking advantage of this edge. With that said,
let’s again talk conceptually about what’s going on with the CVR signals. For
example, when a CVR buy signal occurs, and it is correct, it is correctly
predicting price direction and volatility direction at the same time. It really
doesn’t get much better than this for option traders. There are multiple
strategies to take advantage of such signals ranging from selling naked puts
(not advised, but certainly gives you the biggest edge) to trading verticals.
Larry Connors
Let’s walk through this one step further. By selling premium on a CVR buy
signal, you will have price exploding on the underlying (which means your short
premium is imploding in your favor), and you have volatility imploding which is
causing further good erosion on your short position. Plus, because these signals
are two to four days in nature, you also have theta (time) working in your
favor. Again, it doesn’t get much better than this.
Larry Connors
Let’s go to a CVR sell signal. The correct strategy here is to be long put
premium. The reason being is that when the signal is correct, price will move in
your favor, increasing the value of your put, plus volatility is also moving in
your favor, increasing the value of your put.
Larry Connors
As with all these strategies you want to be in the market approximately two to
four days, and you’ll want to make sure you use the correct stops to protect
yourself when the signals are wrong. As far as the perfect strategy to trade
with this, that is 100% up to you, you’re the only one who knows what’s best
based upon your trading style and risk tolerance.
Larry Connors
It was just brought to my attention that we have a much larger audience than we
anticipated. I will start answering some questions right now. I’ll do my best to
answer as many as possible, and for those of you who I don’t get to in this
session, please continue sending your questions to tradertalk@tradingmarkets.com,
and I’ll do my best to get back to you. Duke just told me if I was Haggerty, I
would stay here till midnight to answer these questions, but there’s only one
Haggerty in this world (thank goodness!).
Larry Connors
Here’s the first question, and a number of you have asked this question in one
form or another: Do the VIX rules apply to the VXN and QQQ?
sukidwyer
VXN is lowest since this summer. What should one expect for the near future? Will
NDX go down soon?
Trial4778
What strategy do you suggest for placing stops when you are trading options with
CVR signals?
Larry Connors
I have never really done extensive testing on the VXN. My initial testing (and
my instincts) say that the rules work the same, and there should be some sort of
edge there. I would prefer testing this for at least a 5-year period of time
before committing to this any further, but there should be an edge here.
stoc
For CVR 3, the 10-day moving average … of the closes?
Larry Connors
Second question, and again, a number of you have asked this in one form or
another: What percentage of the time do multiple signals occur? Multiple signals
occur more often than you think. On average, when our Market Bias page has one
signal pointing in one direction, about half the time it will have another one
pointing in the same direction. And to reiterate what I said earlier, the
multiple signals do increase the chances of success with the trade.
nobelony
Do the rules apply for options on the OEX?
julhirt
How about the QQQ?
Larry Connors
Some of you have asked about the recent low VIX and VXN levels. As some of you
may know from reading my weekly column or being a subscriber to my service, the
VIX has now spent a good part of the past two months under its 20-day moving
average. The same goes for the VXN. This by itself is not a signal that the
market is going to sell-off immediately, but it does give you a good heads up
that there is a great deal of complacency in this market.
Another example of this complacency was Monday night’s action in the VIX.
Even though the S&Ps lost nearly 10 points for the day, the VIX barely
budged, and in fact, closed near a four-month low. Both VIX actions combined were
telling you loud and clear that the complacency out there is at an extreme, and
certainly today’s rapid, sharp sell-off occurs over and over again when these
extremes get reached. This is not a 2002 event or a recent market event; this
type of behavior has been exhibited by the marketplace for decades and will
continue to occur for decades to come.
Larry Connors
Some of you asked about conflicting signals, meaning one CVR signal is pointing
up and one CVR signal is pointing down. The answer is simple: PASS THE TRADE.
There is no edge here.
Larry Connors
A number of you are sending me questions on daytrading using the VIX. It gets a
bit more complicated than meets the eye to answer these questions briefly. I’ll
do my best over the next few days to answer each of you on an individual basis
based upon your specific daytrading question.
jspaulson
On the chart it appears a buy signal was given on approximately Nov. 29 — 5-day
high and close below the open. Yet this day is not flagged as a buy day. Am I
looking at it wrong or was the data filtered?
daysales
Can you tell us what new or modified signals are covered in your latest book?
avs
How do you incorporate the four other non-CVR indicators shown on the Market
Bias Indicator Page?
Larry Connors
A couple of you have asked the question about when the signals on the site are
updated. For those of you who are TradersWire Interactive subscribers, Greg Che
comes on the Wire a few minutes before the close and gives you the signals that
look like they will likely trigger at the close. On the TradingMarkets site and
on my subscription service, the signals are updated nightly at approximately
7:30 p.m. EST.
Larry Connors
Again, this question gets asked in various ways. The question is “What if
the CVR signals conflict with the other Market Bias indicators?” My answer
is: If one CVR signal conflicts with another CVR signal, you’ll want to pass on
the signal. Again, there is no edge. If a CVR signal conflicts with a TRIN
thrust signal, or the momentum index indicator, the CVR signals override those
signals, and the CVR signals should be taken.
mickeymfa
What kind of stop is best used to trade CVR signals? Example: Trading puts on a
CVR sell. How do we set stops, based on option price or index itself?
Larry Connors
Another question that keeps coming in in one form or another was specific entry
triggers and stops. My answer is that there are two ways to do this. One is that
you can anticipate the CVR signals occurring and enter the market intraday. This
would be especially true by placing stops at some level away from the market
which will only get triggered if the market strongly reverses intraday. This
will many times give you a head start to the signals (but is far riskier than a
mechanical market on close entry when you know the signals will be there for
sure). The other entry is simply to wait for the signal to occur, and then enter
either on the futures at the close, or for stocks, on the market opening the
next day.
Larry Connors
The second part is the exit strategy. In my book Trading Connors VIX
Reversals, we show two- and three-day mechanical exits, and the results
speak for themselves. For many traders, this works fine; for me it does not. I’m
much too hands-on. I need to be moving my stops and adjusting my positions
appropriately when I can. Again, this is a personal choice. The most important
thing is to use the CVR signals to gain an edge and then take advantage of that
edge.
Larry Connors
We’ve now been going for more than an hour, and I’m going to wrap this up. I’d
like to thank everyone for attending our first session of TraderTalk. I hope you
enjoyed it, and more importantly, learned something from it. If you have any
questions, you can send them to tradertalk@tradingmarkets.com or send them
directly to me at lconnors@tradingmarkets.com. Thanks again for attending…Dave
Landry will be here next week.
carlsucco
Thanks.
jchaulk
Thank you, Larry.