Using Fear To Time The Market

[jswanson 10]

Would you like to see a timing method that is 75% correct and consistently pulls money from the S&P 500 market since 1997? The following trading strategy is called the VIX Stretch Strategy and was found in a book called “Short Term Trading Strategies That Work” by Larry Connors and Ceasar Alvarez. The concept is executed on a daily chart of the S&P E-mini futures market and the rules are very simple.

 

1. Price must be above its 200-day moving average
   
2. VIX must be stretched 5% or more above its 10-day moving average for 3 or more days
   
3. Exit when 2-period RSI crosses over 65
   

 

Simple yes, but also powerful.

 

A 200-day simple moving average (SMA) acts as a simple market environment filter by dividing the market into two major mode: bullish and bearish. Since the strategy only goes long, trades are initiated if the closing price is above the 200-day SMA filter.

 

The next rule utilizes the VIX which is a measure of the implied volatility of the S&P 500 index options. This is sometimes called the fear index. Why? You will see this index climb dramatically when the market sharply falls and market participants become fearful. Thus, spikes in the VIX index are often associated with steep or dramatic market selling. Since we are looking for a market downturn to open a long trade when we are within a longer term bullish trend, we use the VIX index to gauge the market downturn. Buying the dips within an overall bull market is a classic trading setup. It’s also interesting to note we are not simply using price action to gauge a market downturn. By using VIX to gauge the level of the market downturn we are measuring the increasing volatility seen in the S&P 500 index option prices. Thus we are not measuring a pullback in price directly, but indirectly.

 

The final rule is our exit rule which uses a 2-period RSI. Upon the close of the daily bar the RSI is calculated and if this value is above 65 we exit at the close. I coded these rules in EasyLanguage to see how well they would perform. It did rather well. The results below are from 1997 through March 2011. $20 for slippage and commissions was deducted per round trip.

 

 

The code I used to generate the results is available at the bottom of this post. Is this a complete trading system? Please note the code used to generate these results has no stops! Most people would consider this a complete violation of the rules. I myself would not trade without stops. So a catastrophic hard stop may be added. In closing this timing strategy is a great seed idea for building a complete trading system. With a little creativity I’m sure you could turn this into a great system.

 

DOWNLOAD

 

Please note, the trading concept and the code as it is provided is not a complete trading system. It is simply a demonstration of a robust entry method that can be used as a core of a trading system. So, for those of you who are interested in building your own trading systems this concept may be a great starting point.

 

The EasyLanguage code (text file) can be downloaded here.

[BlueHorseshoe 10]

Thanks for another great thread. I have read the book you reference, but never got as far as testing this particular strategy.

 

An interesting idea with the Connors methods is to use them to filter one another, for example requiring that both the VIX and the 3 Down Days condition you discussed in another thread are both met for an entry.

 

I think that the major issue for most traders here will always be the lack of a hard stop set at the time of entry. It would be interesting to know Connor and Alvarez's own views/research/methods for managing risk.

 

Bluehorseshoe

[onesmith 10]

If my assumption about stops is correct ..... any stop loss will ruin this strategy. The next logical test is a quasi stop loss that inverts the logic and sells short.

 

Anyone have time to test this .. or already knows how that scenario would also ruin it?

[jswanson 10]

Thanks for another great thread. I have read the book you reference, but never got as far as testing this particular strategy.

 

An interesting idea with the Connors methods is to use them to filter one another, for example requiring that both the VIX and the 3 Down Days condition you discussed in another thread are both met for an entry.

 

I think that the major issue for most traders here will always be the lack of a hard stop set at the time of entry. It would be interesting to know Connor and Alvarez's own views/research/methods for managing risk.

 

Bluehorseshoe

 

The system only holds trades for a few days, max. With such a short hold time I would think deep in the money options would be a great way to trade this. Thus, you would have your downside risk controlled and have plenty of leverage for the ride up. However, this is just my guess. I don't trade options.

 

I also agree combining the different Connors methods would be interesting.

[BlueHorseshoe 10]

The system only holds trades for a few days, max. With such a short hold time I would think deep in the money options would be a great way to trade this. Thus, you would have your downside risk controlled and have plenty of leverage for the ride up. However, this is just my guess. I don't trade options.

 

I also agree combining the different Connors methods would be interesting.

 

Personally I just do this sort of thing without stops and very little leverage. I have wondered many times about employing options, but frankly I just can't be bothered trying to understand them.

 

As far as combos go, the strategy above is pretty much a combination of the VIX for entry with one of Connors beloved RSI rules for the exit, but I was referring more to a combined conditional entry(or exit) criteria.

 

I finally realised the other day that you're a vendor. And that you're in business with the very clever guy from Adaptrade whose code I have spent many hours typing out. As a rule I don't tolerate vendors well, but I did find your website very interesting and will undoubtedly return for a more throrough read . . .

 

Bluehorseshoe

[jswanson 10]

Personally I just do this sort of thing without stops and very little leverage. I have wondered many times about employing options, but frankly I just can't be bothered trying to understand them.

 

As far as combos go, the strategy above is pretty much a combination of the VIX for entry with one of Connors beloved RSI rules for the exit, but I was referring more to a combined conditional entry(or exit) criteria.

 

I finally realised the other day that you're a vendor. And that you're in business with the very clever guy from Adaptrade whose code I have spent many hours typing out. As a rule I don't tolerate vendors well, but I did find your website very interesting and will undoubtedly return for a more throrough read . . .

 

Bluehorseshoe

 

It's true! I'm a blood-sucking vendor. I'm also a cold hearted speculator. So be warned!