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This is a study I ran about a year ago, but it's still relevant today...
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.
VIX must be stretched 5% or more above its 10-day moving average for 3 or more days
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. Its 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 Im 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.
That approach certainly makes sense, and I think that it can be even applied to intraday trading wuth some modifications.
(1) Use a trendfilter such as a 200 SMA to determine whether ES is bullish or bearish.
(2) Wait for an extreme reading of the VIX or the front month VIX future.
(3) Enter a position when the VIX moves back into normal territory.
(4) Exit part of the position based on an oscillator, trail part of the position.
For intraday trading I would not used a fixed percentage channel but a Keltner Channel and enter the position, when the VIX has moved outside the Keltner Channel and closed inside again.
As this approach typically detects (safer) retracement entries, I would try to trail part of the position and not exit the full position based on an oscillator.
It would be interesting to backtest this approach. I believe that it has some potential.
For intraday trading, the TICK, TRIN and the ADD are the market breadth indicators that I like to watch.
As explained by Barry Taylor, the raw TRIN is upside down and distorted, so it's better to use the inverted log of the TRIN. (See "Better TRIN" on emini-watch.com.)
Here is an example of how I would use them. I am in beta mode for now. These were two SIM trades.
After the good economic numbers came out it was time for a Wash and Rinse cycle to give The Boyz better entries. So I made a couple of long sim trades to see how helpful it would be to watch market breadth indicators.
The system did not trade that year. Price must be above the 200-day simple moving average before it will take trades. Much of 2008, if not all (going from memory), was under the 200-day SMA.
