The following was
transcribed and edited from TraderTalk, a free, live, interactive workshop
conducted for TradingMarkets members by Larry Connors.
What Is The VIX?
In my opinion, the VIX is the best
market-timing indicator available for short-term traders today. The VIX is,
simply, a measurement of the implied volatility of the at-the-money OEX Index
Options. High VIX readings usually occur after markets experience sharp
sell-offs, when fear is rampant and sharp reversals to the upside tend to
occur. Low VIX readings (as we are seeing
now) usually occur when the market rises. This is a signal that there is complacency
in the market and a sell-off is
Why Does The VIX Work?
four rules will help you understand why VIX signals work:
1. All volatility is mean-reverting. This simply means that periods of low
volatility will be followed by periods of high volatility, and vice versa. The
academic world proved this nearly 50 years ago, and it’s one of the few
truisms of market behavior. The reason this is important is that when the VIX has a high reading and begins
to revert to its mean, it’s also accompanied by a market that begins to rally.
Same thing for low VIX readings — when it begins reverting to its mean, many times
it’s accompanied by market sell-offs. Keep that in mind whenever you’re
looking at a VIX chart in the future.
2. Volatility is auto-correlated. That means if the VIX rises today, it has a
better-than-even chance of rising tomorrow. This is most
significant at market extremes and right before reversals.
3. This is the one that gets most traders on Wall Street messed up (and if you
only learn one thing from this session, this is the most important): The VIX is dynamic, not
static. Simply saying that you buy the market
when the VIX goes above 30, and sell the market when it trades around 20, is sheer
B.S. The Press over the past couple of years has done a wonderful job of
engraining this into traders’ heads, but nothing could be further from the truth.
Blindly entering the market because the VIX reaches some pre-determined level
will eventually get you killed.
4. As mentioned before, the VIX measures fear. High VIX means that fear is high,
low VIX readings mean that fear is low. History has proven (and the CVR signals
have statistically proven) that approximately two out of three times, when these
market expectations occur, a top or bottom is in place and we’re going to look
to fade these expectations as we know we will be right approximately 65% of the
I will now teach you two of my 10 CVR strategies. Both of these strategies
can be found nightly on our Market Bias page. Also, all the strategies can be
found in my book Trading
Connors’ VIX Reversals and in my nightly service.
(Why do I feel like Landry right now, shamelessly plugging my stuff?)
The 10 CVR signals as a whole over the past nine years have correctly predicted
two- to three-day market direction for the S&Ps approximately 65% of the
time. The CVR 3 and the CVR 7 have correctly predicted direction nearly 70%.
First, let’s look at the CVR 1 signal, which is the most basic of signals,
and then we’ll look at the CVR 3, which is one of my favorites.
CVR 1 Signal
The rules for the CVR 1 are simple: For market buys, we are looking for the VIX
to make a 5-day high and close under its open. For sells, we are looking for the
VIX to make a 5-day low and close above its open.
Let’s talk conceptually about what is going on here. First, a 5-day high or
low for the VIX tells us that the market on a short-term basis may be reaching
some extreme. By waiting for it (for buy signals) to make a 5-day high and
then at the same time closing below its open (remember rule #2: Volatility is
auto-correlated), we are finding a market that may be experiencing a sentiment
extreme and has a higher-than-average probability of reversing for the next two to
Take a look at some of the CVR 1 buy signals that occurred during the month of
December and helped us open up this year. As you can see, it did a good job of
identifying swing lows throughout the month.