Bill L.'s  Instablog

Bill L.
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Methodology: setups require certain criteria to be met before trades can be executed, which include weighted statistical studies on several indicators of price, breadth, volume, and sentiment . Amount of risk taken is proportional to how many indicators are aligned. I mainly trade market... More
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  • Q&A: Using The VIX To Time Trades 2 comments
    Jun 19, 2012 8:17 PM | about stocks: VXX


    Sundate36: It seems to me that the market moves in tandem with the VIX cycle that conveniently seems to coincide with FOMC meetings. The bottom range in VIX seems to correspond with the top in S&P, so if this scenario plays out again we can expect these overbought conditions to persist into the first week of the next cycle in VIX futures (tomorrow is the expiration date) and then we'll probably start seeing a decline. What's your take on this, Bill?


    The peak I'm looking for could indeed take a bit more time to form. There are typically two types of pivots, sharp and rounded. Peaks in the market tend to take on the more rounded shape, but that is more of a tendency rather than rule. So you may indeed be right, that it may take a few more days.

    I like to look at the VIX as well as the put call ratio in tandem.

    (click to enlarge)

    Notes: We can see in this chart that when the VIX is low, and the put call ratio is skewed to the call side, there's generally some sort of intermediate peak nearby (and vice versa). You may also note from this chart that while the VIX is low, the put call ratio is not necessarily showing a lot of optimism. This would seem to back up your call for a peak several days from now rather than tomorrow.

    That said, I tend to find that sentiment based indicators (I consider the VIX and the put call ratio sentiment indicators) the most useful as background indicators rather than timing tools. I'd tend to take a cumulative approach when looking at market indicators. For example, while the put call ratio is not screaming excessive optimism, I would say that roughly 75% of the indicators I watch are in zones where I would consider looking for a top. That's typically enough for me to start considering trades on the short side.

    The other way that I use the VIX is, if we do get a reversal in the S&P, I will look for a corresponding move higher in the VIX, for example:

    (click to enlarge)

    A move below the bands would tip me off that the move higher is complete, however before putting money at risk and executing a trade I would look for confirmation.

    (click to enlarge)

    An example of confirmation I would look for, would be a corresponding break out in the VIX above the bands.

    (click to enlarge)

    Further examples of corresponding confirmation would be a decline below the bands in the 10 year treasury note yield. Other confirmation I would look for would include a breakout in the TLT, the UUP, a breakdown in the FXE, etc.


    It may indeed take another week for the top to be in, giving the VIX time to get even lower, and to push down the put call ratio further towards the call side. That said, when enough of the indicators I follow have reached an overbought status I find that you don't necessarily need to wait for every single indicator to line up before the market turns.

    I also use the VIX as part of my list of confirmatory indicators. The more expected corresponding moves (compared to the move in the SPX), the more faith I have that my trade is correct. Lots of confirmation generally makes me use a less aggressive stop, add to positions in strategic instances where the market allows, and generally makes me give the trade a little bit more leeway. For example, if the market starts trending down, and there's a lot of confirmation and the other indexes that I watch, I would be more likely to assign a wider stop to the trade (increasing the amount of risk I'm taking). If the VIX did not rise, that would make me have less faith that the market was done rising, and I may use a more aggressive stop or a smaller position size.

    -Bill L.

    Stocks: VXX
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  • Bill L.
    , contributor
    Comments (691) | Send Message
    Author’s reply » A small favor to ask...
    Help me break the top 10 instabloggers list here at Seeking Alpha!


    Like the analysis you get here? Please tell your friends to add me to their following.


    -Bill L.
    19 Jun 2012, 08:21 PM Reply Like
  • sundate36
    , contributor
    Comments (291) | Send Message
    Bill -- thank you very much for a detailed response!
    19 Jun 2012, 10:49 PM Reply Like
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