Saturday, January 29, 2011

VIX Up 20% in One Day: Bearish Volatility, Bullish S&P 500


Oh boy, the VIX really went off on Friday, rising 24% with huge Futures volume. It was the biggest one day rise since May 20, 2010.  Fear is in the air, primarily due to the unprecedented political events occurring in Egypt. While we do have reasons to be fearful, 24% is a HUGE pop for the VIX, and a lot larger than I was expecting on a day like this. So I wanted to look at the action of the VIX the week following a 20% up day. The table below is presented as if you could trade the VIX directly. It is just for visual purposes; you can't actually trade the Index.

Buy VIX after it's risen 20% in one day; sell 'n'days later. $10,000 per trade; 1990 to present.
Net Profit
# Trades
# of winners
% of Winners
Max. Trade % DD
Avg % P/L
W. Avg. Profit
L. Avg. Loss
Profit Factor
Payoff Ratio
1
   (14,661.46)
42
11
26.19
-18.06
-3.49
       696.72
         (720.17)
0.34
0.97
2
   (22,930.61)
42
12
28.57
-29.57
-5.46
       762.07
     (1,069.18)
0.29
0.71
3
   (28,188.61)
42
9
21.43
-31.15
-6.71
       908.29
     (1,101.91)
0.22
0.82
4
   (36,815.69)
41
7
17.07
-37.68
-8.98
       936.34
     (1,275.59)
0.15
0.73
5
   (38,060.43)
40
10
25
-37.68
-9.52
       698.69
     (1,501.58)
0.16
0.47


This shows that volatility usually drops after a big 20% up day. This makes sense. We had a major 24% move and the VIX is a mean reverting instrument. There's going to be some retracement.

I also wanted to look at the VIX action when one of these 20% up days occurs on the last trading day of the week. Will the weekend give people time to process the fearful events? Will cooler heads be trading on Monday morning?


Buy VIX after it's risen 20% on the last day of the week; sell 'n'days later. $10,000 per trade; 1990 to present.
Exit n
 days
Net Profit
# Trades
# of winners
% of Winners
Max. Trade % DD
Avg % P/L
W. Avg. Profit
L. Avg. Loss
Profit Factor
Payoff Ratio
1
      (6,441.21)
15
3
20.00
-29.57
-4.29
    1,163.98
          (827.76)
0.35
1.41
2
    (12,640.67)
15
1
6.67
-30.84
-8.43
    1,395.27
      (1,002.57)
0.10
1.39
3
    (15,527.52)
15
1
6.67
-37.68
-10.35
       237.69
      (1,126.09)
0.02
0.21
4
    (19,777.90)
15
0
0.00
-37.68
-13.19
   N/A 
      (1,318.53)
0.00
 N/A
5
    (20,774.51)
15
1
6.67
-37.68
-13.85
            9.44
      (1,484.57)
0.00
0.01


Less occurrences, but further support for a volatility contraction. But the "average profit" on the first and second day caught my eye. The VIX rarely closes up on the first or second day after the 20% move, but if it does, it usually goes up BIG. So I wouldn't be surprised if there is a continued spike in volatility on Monday/Tuesday before a swift drop off.

Applying this scenario to the S&P 500 Index, SPX, we get this:


Buy the SPY when the VIX has risen 20% in one day; exit RSI(2)>65. 1990 to present.
Exit n
 days
S &P 500 Points
# Trades
# of winners
% of Winners
Max. Trade % DD
Avg % P/L
W. Avg. Profit
L. Avg. Loss
Profit Factor
Payoff Ratio
1
         573.58
41
32
78.05
-22.90
1.44
        23.35
         (19.30)
4.30
1.21


I added an exit when RSI(2)>65 but you could use any exit (first up day or close > 5 day MA) and the results are positive. This looks like a classic case of being 'greedy when others are fearful'.

As usual, be sure to consider your own factors before taking any action. With the Egypt unrest and the market seemingly on the verge of breaking down, we should have an interesting open Monday.

Good trading out there.


-----------------------------------------------------------------------------------------------------------------------

Last 10 $SPX Trades:


Ticker
Trade
Date
Price
Ex. date
Ex. Price
% chg
# bars
$SPX
Long
12/1/2008
816.21
12/3/2008
870.74
6.68%
3
-0.06%
8.87%
$SPX
Long
1/20/2009
805.22
1/27/2009
845.71
5.03%
6
-0.11%
5.88%
$SPX
Long
10/30/2009
1036.19
11/5/2009
1066.63
2.94%
5
-0.66%
2.94%
$SPX
Long
11/27/2009
1091.49
12/1/2009
1108.86
1.59%
3
-0.71%
1.59%
$SPX
Long
1/22/2010
1091.76
2/2/2010
1103.32
1.06%
8
-1.85%
2.17%
$SPX
Long
2/4/2010
1063.11
2/11/2010
1078.47
1.44%
6
-1.75%
3.21%
$SPX
Long
4/27/2010
1183.71
4/29/2010
1206.78
1.95%
3
-0.18%
2.34%
$SPX
Long
5/6/2010
1128.15
5/10/2010
1159.73
2.80%
3
-5.53%
3.50%
$SPX
Long
5/20/2010
1071.59
5/27/2010
1103.06
2.94%
6
-2.88%
3.34%
$SPX
Long
6/4/2010
1064.88
6/10/2010
1086.84
2.06%
5
-2.13%
3.15%

Thursday, January 27, 2011

Information Flow, Free Ideas and What We Do With Them

I recently read some interesting posts out in the blog world. One was from DynamicHedge about the cost of free information and why he'll never give out his best trading ideas for free. I agree with him - why would you give out your best for free? But then again: what's an idea worth? Surely, there must be some value there. But in order for a trading/market related idea to have value, you have to do something with it. Someone could tell me a about a perfect setup or a very compelling study. But if I don't do anything with it, then was it even worth anything? I write out my ideas for me; it's a helpful process to think out loud through the web. Sometimes I'm not even sure if I even have a good idea or not, but the process of writing usually clears that up. Before an idea can be deemed good or valuable, it comes back to a person's perception of that idea and what they do with it.  On Sunday, I wrote about a bullish scenario for the NASDAQ setting up this week. It sounded like a good idea to me, but not that good where I thought I was giving away some super edge.  If you trade the NASDAQ, it probably had value to you. But if you're a pennystocker or breakout trader or forex mover, maybe not so much. So good ideas can add zero value, depending on the trader. Additionally, for an idea to add value, it doesn't always mean that action needs to be taken.

That thought takes me to something I read on Derek Hernquist's blog. It was part of his 2011 goals, #7: "Use models not to predict, but to create a range of possible outcomes for which we can plan." It's a great quote and is a perfect way too sum up what I'm doing on this blog. Some studies are basically trading signals to me, so they are trying to predict.  But often a study can be valuable even though I take no direct action. A did one about 2 weeks ago anticipating an increase in volatility. I took no volatility-related trades (i.e. VXX) , but it was valuable to me because it gave me potential scenarios for what could happen. There were a range of outcomes for which I created a mental plan. I'd rather plan for something and have it not come to fruition, then be completely caught off guard with no plan. Last week, I was ready for more volatility in individual stocks, and I managed my positions with that in mind.  I primarily buy pullbacks, so I planned to adjust entries (if need be) based on the idea that some stocks may pull back further than normal ('normal' being the past 2 months).  I'm not sure if that's a flawed conclusion, but that's what I came to. I also had it in my head, 'volatility should be rising, earnings season starts; I'm expecting some whipsaws.' Even if there were no whipsaws, at least I was ready for them.

Information is at the cornerstone of trading: access to it, understanding it, then utilizing it. There is so much out there (Twitter, StockTwits, blogs, CNBC) that it can be difficult to wrap your head around all of it. Yes, sifting through all the data can be an arduous task, but it is necessary and you have to practice at it. The speed and efficiency at which you process information only improves with experience. You have to keep studying to market on a daily, repetitive basis, and eventually you will turn the corner. We've chosen to be traders, possibly the most challenging and competitive career in the world, but one of the most rewarding and lucrative. I may be stating the obvious here: trading is not easy. We're almost f'd before we even start. It's a game where cheating is commonplace and the rules change every day. By learning to properly filter and process information, I feel like I can sort of play with the big boys. I can get a dog in the hunt. Running backtests allows me to develop quality trading plans that will help me maintain longevity in this business. Hopefully, many of you agree with that sentiment and are willing to share certain information that will benefit the masses without sacrificing your own trading performance or devaluing your hard work.

Good trading out there.

Sunday, January 23, 2011

Ruffled Feathers and Buy Signals on the $QQQQ and $NDX


The MLK holiday shortened week sure was an exciting one. Volatility perked up like I anticipated and it seems like every bull has been converted to a bear after 3 down days on the Q's.  Some feathers have been ruffled and undergarments bunched because of a whopping 2+% weekly loss. Yes, the rally is taking some pressure and a correction may be imminent, but we may have temporarily over-reacted to the price action of the market.

Right now, the QQQQ is short-term oversold by most of my indicators. Below are some thoughts and studies about our tech indexes.

QQQQ Down 3 Straight Days

The Q's are still in an uptrend, as evidenced by a close above its 200 day MA. Looking at its RSI(2) reading of 6.50, it would be considered oversold [anything below 10 is OS]. And being down 3 straight days is not as bearish as you might think. So here goes:


When QQQQ drops 3 straight days and has RSI(2)<10, buy on close > 200 day MA; sell when RSI(2)>65. $10,000 per trade; 2000 to present.
Net Profit
# Trades
# of winners
% of Winners
Max. Trade % DD
Avg % P/L
W. Avg. Profit
L. Avg. Loss
Profit Factor
Payoff Ratio
1
     4,193.20
53
37
69.81
-13.20
0.79
      201.71
       (204.39)
2.28
0.99


So this event is not negative. One thing to note is that this study uses a dynamic exit [RSI(2)>65] vs static [exit 'n' days later]. Dynamic is always better than dynamic in my opinion. The average winners are about the same as the losers, but the 70% win rate makes this study bullish. Average hold is 5 days.

VXN Stretched and NDX Oversold

VXN, CBOE NASDAQ 100 Volatility Index, was up over 22% on the week. I noted what happens when the VIX rises 20% on the week, and the activity of the VXN mirrors the VIX under these circumstances.
I've also noted how stretched VXN is above its 5 day moving average: 5% above the 5 day MA for 3 straight days. This VXN condition plus an oversold RSI(2) level below 10 is usually a short-term buy signal for the NDX.


When VXN is 5% above 5 day MA for 3 straight days, buy NDX on close > 200 day MA and a RSI(2)<10;  Sell RSI(2)>65. $10,000 per trade; 2000 to present.
Net Profit
# Trades
# of winners
% of Winners
Max. Trade % DD
Avg % P/L
W. Avg. Profit
L. Avg. Loss
Profit Factor
Payoff Ratio
0.94
   6,412.45
68
51
75.00
-12.78
0.94
     198.45
     (218.15)
2.73
0.91


Similar to the other study, average win and losses are about the same, but the winning % indicates a bullish bias.

NASDAQ McClellan Oscillator at -50



The NASDAQ McClellan Oscillator is also at -50,  which is also short-term oversold and bullish. I noted it in a bullish study here, so it is another thing to keep on your radar for the week.

Conclusion

With all the sketchiness out there over the last week, there are studies in play that play that are actually bullish. Of course, we can go lower again Monday, but with every additional down day, the NASDAQ becomes more oversold and susceptible to a nice short-term bounce. Please note that these studies are most concerned with the activity over the next few days. There could be a pop Mon/Tues, then a another whoosh downward. I'm just trying to catch the pop. We may enter a correction that may last a few weeks/months, so be aware of your time frames.

Good trading out there.

1/24/11 Note: QQQQ and NDX closed today with a RSI(2) of 66. So the study is closed, 1.4% positive.