TheCBOE VolatilityIndex (VIX ) is a widely followed sentiment
indicator. WhenVIX is high, it indicates that traders are worried
aboutmarket declines. StreetAuthority writer Amber
S&P 500 (
that demonstrates fear rises with a price decline and fear peaks as
prices near the bottom.
This simple chart may not allow us to predict market turns, but
it offers extremely valuable information. VIX can be used to
confirm trend reversals. If VIX drops as prices rise, then it would
indicate we have probably seen the bottom.
Because VIX is calculated from the premiums traders pay on
options contracts, its value is specific to the S&P 500Index .
Other calculations of similar indexes are published for the Nasdaq
100, the Dow Jones Industrial Average, the Russell 2000, gold, oil
and eurofutures .
Limited availability led author and trader Larry Williams to
develop an indicator he calls the "VIX Fix," which can be applied
to anystock orETF . The chart below shows SPY with the traditional
VIX in the middle and the VIX Fix at the bottom. A 20-daymoving
) has been added to each indictor. The general trends in both
indicators is the same, but I think the VIX Fix makes sharper moves
and is easier to interpret.
The VIX Fix uses the same general formula that is used to
calculate thestochastics indicator . The difference between the
highest close in the past month and today's low is divided by the
highest close in the month. That ratio is multiplied by 100 to
scale the indicator from 0 to 100. The formula would be:
[Highest (Close, 20) - Low] / [Highest (Close, 20)] x
Where "Highest (Close, 20)" means the highest closing value in
the past 20 days and "Low" refers to the current day's low.
This indicator extends the powerful concept behind the VIX to
any stock or ETF. Applying a simple trading strategy to SPY shows
how well this indicator can work. If fear is rising, then we expect
the market tooffer a buying opportunity and we will go long when
the VIX Fix is greater than the 20-day moving average. The system
will be short when fear is falling and the VIX Fix is below the
This system is not designed to catch tops and bottoms, but is
designed to test how useful the VIX Fix is. It is not optimized and
could be improved upon, but it works fairly well.
This system would be a winner on 69% of the long trades and
57.9% of the short trades. As the chart above shows, traders would
be short SPY right now based on these rules.
VIX Fix can be applied to any market, and when testing it on
thestocks that make up theNasdaq 100 index , we also see profitable
results. Long trades were profitable 63% of the time and 56.9% of
the short trades were winners. Using a basket of 40
offering exposure to international stock markets, 63.7% of long
trades are winners and 54.3% of short trades are profitable.
Right now, the VIX Fix points to
Market Vectors Russia ETF (
as a buy. Abuy-and-hold investor would have lost about 18% of
theirmoney if they had bought RSX when it began trading in May
2007. The VIX Fix trading system would have delivered a gain of
more than 81% during that time and 65.4% of all the trades would
have been winners.
Action to Take -->
Buy RSX at themarket price . Set stop-loss at $28.35, about 5%
below the current price (that is the average loss on losing trades
with this strategy). Set initialprice target at $37, the target
from aconsolidation pattern that has formed since last spring, for
a potential 24% gain.
This article originally appeared on ProfitableTrading.com
Little-Known Indicator With a 65% Win Rate
Signaling a 'Buy'
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