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The VIX Reversal strategy was developed by trader-author Dr. Thomas K. Carr. It is published in his book Micro-Trend Trading for Daily Income (isbn 978-0-07-175287-9). The strategy uses the volatility index (VIX) published by the Chicago Board Options Exchange (CBOE). Carr claims in his book "The VIX Reversal system" … is my most profitable system in volatile markets.
|Suitable for||: S&P 500 market index
: Stocks, including ETF
|Instruments||: Futures, CFD, stocks|
|Trading type||: Day trading|
|Trading tempo||: 2-5 signals per day on a 5' chart|
|Using NanoTrader Full||: Manual and (semi-)automated|
The market volatility index (VIX) is a popular measure of the implied volatility of the S&P 500 index options. The VIX is broadcast by the CBOE and is often referred to as the fear index. In a nutshell, if the VIX climbs the market tends to go down. If the VIX goes down, the market tends to go up. It is interesting to note that the VIX is a forward-looking instrument in the sense that it is indication of what professionals expect the rate of return on the SP500 to be next month.
Many financial instruments are based on the VIX. In the case of futures there is a VIX future. In the case of CFDs there is a CFD on the VIX. There is also a CFD on a VIX exchange traded fund (ETF). Backtesting seems to indicate that for CFDs the CFD VIX ETF seems to give the best results for this strategy. Traders using futures can use the VIX future.
Dr. Thomas K. Carr applies the strategy in a 5-minute timeframe. He uses it for stocks, exchange traded funds and market indices. Carr argues that higher time frames are also possible but is of the opinion that 5 minutes is best.
The VIX reversal strategy uses 5-minute and 15-minute moving averages (MA) of the VIX. When the 5MA crosses above the 15MA a sell signal is given. When the 5MA crosses below the 15MA a short buy signal is given.
The strategy is a reversal strategy. A reversal strategy always has an open position. When a long position is closed, a short sell position is opened at the same time. When a short sell position is closed, a long position is opened at the same time. Only during the night the strategy has no open positions.
When the 5MA crosses below the 15MA a long position is closed (at the same time a short sell position is opened). When the 5MA crosses above the 15MA a short sell position is closed (at the same time a long position is opened). There is no profit target. The VIX reversal strategy also uses a time filter. The time filter will close any open positions in the last five minutes before the market closes.
This example shows a full trading day on Google. There are three buy signals (green circles) and two short sell signals (red circles). When a long position is closed a short sell position is opened. The final long position is closed by the time filter (purple background) at the end of the day. The second window shows the CFD VIX ETF. The third window shows the VIX moving average crosses which give the signals.
This example also shows a full trading day on Google. There are two short sell signals (red circles) and one buy signal (green circle). The example is interesting because it makes the case for adding an emergency stop loss to Carr’s strategy. It is rare that a stock makes such an instantaneous slide intra-day. Nevertheless, an emergency stop loss would have saved the trader money.
The results of the VIX Reversal strategy vary from stock to stock. These screenshots show back-tests for a number of stocks. Given that the strategy is based on a 5-minute time frame the back-tests cover only 8 months. Hence, they need to be interpreted with the necessary skepticism.
The results on Heinz.
The results on Microsoft.
The results on Sandisk.
The results on Teva Pharmaceuticals.
The results on Apple.
The VIX Reversal strategy developed by trader-author Dr. Thomas K. Carr is interesting in that it is based on the VIX. The VIX is one of the few forward looking indicators and is known for being relatively precise. Although there is nothing wrong with simple strategies this one appears too simplistic. The strategy would probably benefit from at least an emergency stop and a signals filter (based on the size of the movement in the VIX). This would limit the number of signals when a stock’s price is moving sideways. It may also be useful to experiment with a profit target or a time stop given that on numerous occasions a large part of the paper profits are lost again before the VIX MAs cross.
In NanoTrader Full follow these steps: