Did you know that you can make your own VIX trading strategy using just price?
The VIX is often called the "Fear Index" and is peddled all over financial media.
I'm going to prove the VIX is utter bunk, just more hot air from people that have never tested trading ideas in their lives.
Then I'll show you how to make the Synthetic VIX, which is far superior.
And finally, we'll make a highly accurate Synthetic VIX trading strategy that times the stock market with 81% winning odds.
What Is The VIX?
The VIX, as you probably know, measures the S&P 500's option premium.
I'm not going to go into all the math, but you can go down a serious rabbit hole if you like.
More or less it measures how much people are freaking out and how much they are willing to pay for downside protection.
I've mentioned this before, but it's worth repeating:
Options traders are notoriously terrible traders.
Anytime people have the ability to control a lot of money with a little bit; things get ugly fast.
(You can open an options account with just $5,000!)
If options traders are so bad, the natural thing would be to take the opposite side of these traders, right?
So when they are paying "too much" for options (the VIX is high and the market is down) you should take the other side and bet the market will go back up.
But You Can't "Eyeball" the VIX
But how do you know the VIX is high enough and at the right price to buy?
Now "technical analysts" will doodle on charts and financial TV personalities will spout useless sound bites when the VIX jumps.
They eyeball the VIX and say things like "The VIX is skyrocketing!"
Not so fast there, hot shot.
They would need a bit more rigor in their thought processes before I'd listen to that terrible advice.
Just saying "The VIX is high" isn't enough.
If we really want to make a VIX trading strategy we'll have to break out some real math.
How to Make Your Own VIX Trading System
Historically, the VIX is all over the place.
Take a look at it over the last 20 years and you'll see it fluctuate more than a hula doll on your car dashboard going over a bumpy road.
In 2008 the VIX hit a high of 89.53 and over the last year, the high was only 50.30.
How in the world can you use a data set that seems to arbitrarily float around?
The key (as with most time-varying data sets) is to: normalize the data.
A super easy way you can do this is using this simple formula:
Synthetic_VIX = (( highest (close, 21) - low) / highest (close, 21)) * 100
All this formula is doing is looking at the range of prices over the past month and dividing by the highest price.
Plug in the price of the S&P 500 and BOOM; you got yourself a synthetic VIX that can be used in a VIX trading strategy.
The VIX Is Just Another Financial Product
Yup, the VIX is just another made-up "indicator" that someone is trying to sell you.
The "fear index" is nothing more than looking at the normalized price of the stock market over the last month.
Now, since we have an objective means to measure these extreme swings in price let's make a trading system that you can use to make money.
Similar to the SPY swing trading system, let's write down some super simple rules for the S&P 500:
- The Price must be going up (a bull market), i.e., prices are above the 170-day moving average
- Buy when there is a move higher in the Synthetic VIX - let's say above 4
- Sell when things get back to "normal" or when the Synthetic VIX comes back down to a reasonable level - let's say below 2
Let's translate these rules into 3 lines of code and see what the computer tells us about our VIX trading strategy.
Using the VIX Trading Strategy with 81% Accuracy
When we buy and sell (in a bull market) the wild ride of the Synthetic VIX we get some great results since 1993 using the S&P 500:
PS. Never risk a dime without testing your trading first using a computer!