In general, the price of a stock is determined by supply and demand, which is measured by the sentiment of the collective investors, the herd. While it is hard to measure the sentiment of one particular stock, it is easy for an index.
VIX (Volatility Index) measures the volatility of Standard & Poors 100 Index by weighting bid/ask quotes of 8 put and call options. It has been used widely by traders as a general indicator of market volatility and sentiment. The VIX is an inverse indicator. High number means excess bearishness, and low number indicates excess bullishness.
VIX is a good short term trend indicator if you’re a contrarian. You buy during excessive bearishness or high VIX; you sell during excessive bullishness or low VIX. But how high is too high, and how low is too low? You can’t tell from just looking at VIX. That is when the Bollinger Bands is here to help like so. Now, you can see when VIX is too high (touching the upper Bollinger line) and when it is too low (touching the lower line).
Below are the buy/sell signals issued by reading VIX.
1/1 (High: Buy signal)
1/7 (Low: Sell signal)
1/12 (High: Buy signal)
1/22 (Low: Sell signal)
2/4 (High: Buy signal)
2/27 (Low: Sell signal)
3/22 (High: Buy signal)
4/2 (Low: Sell signal)
4/23 (Low: Sell signal)
5/17 (High: Buy signal)
5/27 (Low: Sell signal)
There were 2 sell signals issued in April without a buy signal in between. Since the closing price for DOW, S&P100 and Nasdaq were close on both 4/2 and 4/23 dates, I will use the 4/2 sell signal for this demonstration, which is what a trader would do if he followed VIX in real time.
If you were to directly buy and sell DOW, S&P100 and Nasdaq based on the above signals, you would end up more than the buy and hold strategy.
Below are the comparisons using the VIX buy/sell signal vs. the buy and hold strategy since the beginning of 2004 to the end of May.
DOW
+1,074.5 pt (10%) - VIX Buy/Sell Signal
-221.4 pt (-2%) - Buy and Hold
S&P100
+349.0 pt (17%) - VIX Buy/Sell Signal
+19.9 pt (1%) - Buy and Hold
Nasdaq
+59.7 pt (11%) - VIX Buy/Sell Signal
+4.9 pt (1%) - Buy and Hold
Timing with VIX is one of many tools and signals I will put on this blog in the future. It is an excellent indicator for measuring the pulse of the market.
The latest VIX signal is a sell signal, issued on 5/27.
If you believe what the VIX crystal ball is saying, by the end of this week, DOW, S&P100 and Nasdaq will be lower than today’s close of 10202.65, 545.11, 1990.77 respectively.
posted by jason @ 4:51 PM
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