Williams’ VIX Fix

04Sep10

This is a follow up to Mind Money Market’s post re: the Williams’ VIX Fix (WVF). The WVF is a VIX-mimicking indicator that, unlike the VIX itself, could be applied to any intraday vehicle (ETF, futures, etc). Read more about the WVF (pdf).

MMM’s post showed that the stock market has been very bullish following high WVF readings (i.e. high volatility). To illustrate, the graph below shows results from 1994 trading the S&P 500 using MMM’s strategy (strategy rules to follow).


[logarithmically-scaled, growth of $10,000]

The strategy is in red versus buy & hold in grey. It would be wrong to think that because the strategy trailed buy & hold over most of the test that it was inferior; the strategy only spent about 13% of all days in the market so we’re not comparing apples to apples (and not including the significant impact of return on cash).

Strategy rules: go long at today’s close when today’s WVF reading will close in the top 5% of all readings over the previous 30-trading days, otherwise move to cash.

See end of post for assumptions about dividends and trade frictions. Note I’ve used the ETF SPY to calculate WVF, but assumed trades were place on the index itself.

Numbers for the number-lovers…

Clearly the market has exhibited strength following very high WVF readings. Because the strategy spends so little time in the market it’s not going to keep pace with strong bull markets, but when the high-volatility signal has triggered, it’s portended good things.

Things I like about this strategy:

  • High return (actual and risk-adjusted) given limited time in market
  • Bear-resistant

Things I don’t like about this strategy:

  • Because WVF relies on intraday data (in this case, SPY), a very long backtest is difficult (although we could use futures data for a longer look at the S&P 500)
  • At just slightly lower levels of “extreme” WVF readings (say, the top 5-10% of readings rather than the top 5%) the market has actually been bearish rather than bullish. It worries me when small tweaks to strategies lead to such big differences and hints that a good bit of the positive results in this post are the result of curve-fitting

In a follow up post I’ll look at (a) trading this same strategy using the VIX itself (rather than WVF), and (b) applying this strategy to other equity indices.

Happy Trading,
ms

Test assumptions: (a) S&P 500 returns daily dividend-adjusted (interpolated from quarterly data), (b) results are frictionless (do not account for transaction costs or slippage) but could be closely reproduced in today’s market using certain mutual funds less part of an annual expense ratio, and (c) I’ve ignored return on cash.

. . . . .

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5 Responses to “Williams’ VIX Fix”

  1. Interesting, I´ve been thinking of doing a synthetic VIX but have never got my act together. And now I don’t need to!
    This strategy is bad because when you just look at the equity curve you get the idea that high volatility is the reason form this bullish tendencies when actually it´s the mean reversion-effect that plays out. The most volatile times are almost exclusively times that the market falls (I think I recall that you have a post on this) and hence the following performance would be prone to be bullish.
    Lower levels of extreme WVF readings probably contain some times when the market rallied and that would affect market performance negatively in the following days.
    Anyway, I might be completely wrong. It would be interesting to see the correlation between the WVF-strategy and some intermediate OS/OB-strategies. I will run the strategy through some Nordic stocks and see how it does.
    Cheers!

  2. 2 Frank

    Michael,

    great posting, as always.

    I don’t think intraday prices are a must. I slightly modified William’s original formula and replaced the ‘Low’ through the ‘High’ and the ‘Close’ (my most recent posting). At least with respect to the SPY and the QQQQ and utilizing different time frames as well, the ‘Close’ always came up on top (highest rate of return, profit factor, median trade, …).

    Best,
    Frank alias TradingTheOdds
    http://www.tradingtheodds.com

    • 3 MarketSci

      RE to Frank: good stuff sir. One point of clarification…

      When I wrote the bit about “at slightly lower levels of extreme the market was actually bearish” I don’t think I was clear.

      What I meant was that (for example) the top 5% of readings were bullish, the top 10% of readings were also bullish (as a whole), but that 5-10% range was bearish.

      Unlike RSI(2) for example, where the indicator becomes more bullish or bearish the further one moves to the extremes (20 more bullish than 30, 10 more than 20, 5 more than 10, etc), the WVF (as defined by MMM) was only consistently bullish at extremes (and not enroute to those extremes).

      Enjoyed the other observations in your post and I’ll include them w/ my follow up. michael

  3. 4 Carl

    I spent a lot of the early summer (May/June) playing with the VixFix. I found a few things:

    > It can be tweeked for easier calculation/personal preferrence without much ill effect
    >> note in his article Williams mostly compares the weekly to the vix, not the daily… Some tweeking of the formula to get a better match to daily works. Also, the VixFix tends to return to “normal” faster than the real VIX.
    > As it is based on price, it is purely a concurrent price indicator – not a leading or lagging indicator
    > When I applied a fast moving average to it, I found that trades were positive
    >> almost never on the first cross over (the first time the VixFix tried to return to normal readings)
    >> almost always on the second cross over
    >> After a failed second cross over, it became too expensive (whipsaw) to trade the 3rd and 4th crossovers
    >> and if it failed to trade positive after the fifth positve cross over, you basically were at a major market top (it happend in May/June- five attemps and we basically stayed in a range – which we are still in).

    Given that you are trading from the VixFix extreme, you are not waiting for a cross ove like I wasr; and in fact your profits are the xovers I was waiting for to signal a long side trade. Interesting. I may look at this again based on your observations. Maybe – I found as an indicator that the VixFix is a lot like like girl in Longfellow’s poem: And when she was good, she was very, very good, But when she was bad she was horrid.

    Carl


  1. 1 Fix The VIX! Daily Options Report

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