The CBOE Volatility Index, otherwise known as the VIX, is a volatility indicator that measures the expected volatility in the next 30 days. It's often called the 'fear index' by investors as it shows whether it's time to buy or sell stocks. Before I get more into it, let me just say that trading an index like the VIX is extremely risky and trade at your own risk.
What the VIX is Telling Us
Before the stock market crash in March, the VIX was trading under $20. When fears rose due to the pandemic and the government announced a temporary economic shutdown, it jumped up to as much as $80. This was all in a matter of under one month's time. When we saw the VIX at $80, investors knew that fear had taken over lots of money had been taken out of the market. Supposedly, it measures volatility, but from what I've gathered, it behaves as if one were to short the market. Similar to shorting, buying VIX shares does the same thing. It's more of a fear gauge than a volatility meter. If the stock market were to have huge volatility to the upside, the VIX would come down hard.
In the scenario above, the VIX climbed to the top in only 21 days. What I like to point out here is that the VIX clearly has more upside potential than to the downside. If you entered the trade at the $20 mark, the risk to reward was immensely in your favor. In hindsight, if you were to purchase one share of the VIX on February 21 and got in around $18, you were either risking all of your $18 for the potential of making $67.40. That's around 4X what you would've risked had you got in. Coincidentally, the VIX took about four times as long to return to pre-crash levels.
The VIX is telling us that when the market crashes, it comes sudden and aggressive. Understanding when to get in the VIX is very tricky because one moment your opportunity is there, and the next moment it's gone.
How to Trade the VIX
One simple way to pick your entries on the VIX are by looking at the market's relative strength. When the 14-Day RSI is above 70 (overbought) you will usually see some increase in price in the short term.
The line in orange represents the VIX and the candles are the Dow Jones Industrial Average. Notice the blue dotted line showing how RSI was above 70 on DJI before we saw an increase in the VIX. To me, RSI is one of the best indicators that tell you when stocks are over or under valued.
This index is purely meant for trading and is not meant to be held for years at a time. Especially in things like TVIX; your money will move at double the volatility in the VIX. TVIX just means 2X leverage which can either work out very well or very poorly for you.
However, we are in times where uncertainty is high and fears of another shutdown are in the back of everyone's mind. You can expect heavy volatility for a while as the US government tries to figure out what to do about the economy. And risk to reward looks very good right now for the VIX, but it all depends on how much one wants to risk. Some traders have made millions on trading calls and put options on this index, but that requires perfect timing. Many have lost thousands. If you're more confident about 'where' instead of 'when', you can just purchase shares of the VIX without having to worry about an option call that expires after a given time. In other words, if you are fairly confident that the market will go down in the near future but didn't know when it would happen, it is often better to not try to not give yourself a deadline with an option call and grab some shares instead.
All in all, the VIX is a powerful thing to trade and can either work for you or against you just like any stock or currency. But what makes it special is that when the market is losing money, you could be making money. And you can always trade it over and over again. It also tells you how investors feel about the market. Are they confident or uncertain? Are they fearful or are they greedy? It's not only an index you can trade, but it's also an indicator in itself.
Featured Photo: https://voxeu.org/sites/default/files/image/FromMay2014/sentanafig1.png
Thanks for reading! If you are interested in joining our trading community, we have chat rooms, trade alerts from our top traders, and educational content. You can join using the link below, and get a discount on your membership.
Please note that this email is my personal opinion only. I am not a licensed financial advisor, and any information shared or discussed is not to be construed as investment advice. Trading and investing involves a degree of risk, and is not suitable to all investors. Please consult with your financial advisor before making any sort of investment decisions.
Smart Money Tracker
See where big money is flowing with the A1 Edgefinder's smart money tracker! With one click, see where the biggest money flows are entering and exiting through COT data.
Today, Fed chairman Jerome Powell spoke on the labor market and inflation. While we don't know what the future holds for the equities and currency market, we can derive certain conclusions from investors' interpretations. Here are some powerful takeaways from Powell's remarks this afternoon. Key takeaways Market Impact This caused the dollar and equities to […]
Today at 2:00 pm EST, the Fed will announce their latest interest rate decision. Estimates suggest a smaller hike of 25 basis points this time around. Here are some things to consider before the FOMC decision later today: The Fed has struggled to tighten their grip on inflation without causing too much disturbance in the […]
With the holiday season lingering on and a new year on the cusp of arrival, traders may glance at the calendar and notice there is not much economic news to anticipate on Friday to cap off a light week. In situations like these where there can be lulls in bullish and bearish momentum due to […]
DISCLAIMER: All comments made by TraderNick’s Forex Group, LLC are for educational and informational purposes only. All comments should not be construed as investment advice regarding the purchase or sale of any securities or financial instrument of any kind. Please consult with your financial adviser before making an investment decision regarding any securities or financial instruments mentioned by TraderNick’s Forex Group, LLC. TraderNick’s Forex Group, LLC assumes no responsibility for your trading and investment results. All information on any of the platforms utilized by TraderNick’s Forex Group, LLC was obtained from sources believed to be reliable, but we do not warrant its completeness or accuracy, or warrant any results from the use of the information. TraderNick’s Forex Group, LLC, its employees, representatives, and affiliated individuals may have a position or effect transactions in the securities and financial instruments herein and or otherwise employ trading strategies that may be consistent or inconsistent with the provided strategies. Trading of any type involves very high risk and may not be suitable for all investors. TraderNick’s Forex Group, LLC, its subsidiaries and all affiliated individuals assume no responsibility for your trading and investment result. Read our full disclaimer here