Vix Basic

Historical trades (4/20/2009 - 4/26/2022)
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Model Summary
MetricValue
Model CAGR
21.62%
SPX CAGR12.78%
Winning Trades121
Losing Trades93
Win %56.54%
Max Drawdown-19.92%
Max Drawdown duration629 days
Final Value $1,223,900
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Model Description

Overview and Implementation

For maximum responsiveness with 23/5 trading, this model exclusively trades the S&P 500 Futures Contract. However, it can be implemented fairly accurately through any ETF or other instrument that tracks the S&P 500 such as SPY or VOO. The model is always either 100% long SPX or 100% cash. Each trade alternates between these two positions. In practice, many investors implement our models through a hedging system instead. For example, on a buy signal, you would hold your regular diversified portfolio of ETFs and stocks as you do now. During a sell signal, you would sell S&P 500 Futures contracts against the value of your holdings for a net market neutral overall position. This method has the added benefit of lower overall tax liability.

Trade Frequency

Vix Basic is an average frequency trading model with 214 total trades over the 13.29 year period. On average, the model made one trade per 15.65 trading days. However, the trades are not uniformly distributed; during periods of higher market volatility, more trades were made compared to relatively calm periods.

Vix Basic is best for medium term investors and swing traders who want to both avoid large drawdowns and substantially outperform the benchmark. At 56.54% trade win rate, traders following this model will occasionally run into false positives. Think of these as insurance premiums that are well worth paying to avoid the potentially massive drawdowns that are bound to happen from time to time (such as the -36.01% thrashing the SPX took during the COVID-19 crisis).

Key Indicators

This model focuses on the Cboe Volatility Index (VIX), an index that represents the market's expectations for the relative strength of near-term price changes of the S&P 500 index (SPX).

Indicator Overview

A few of the indicators this model uses behind the scenes are:

  1. Absolute VIX level
  2. VIX futures curve shape (degree of backwardation vs contango)
  3. Realized volatility vs implied volatility trend

The model uses these and other minor indicators under varying and adaptive time parameters to identify medium-term trend changes. As with all our models, we run the backtest through our proprietary anti-overfitting machine learning system to ensure we are identifying real and repeatable patterns.

Indicator Analysis

Many savvy traders have been using the VIX to their advantage in identifying local minima and maxima on the daily or weekly charts for a long time. Vix Basic uses several derivative analyses of underlying VIX movement. Some examples:

  • SPX and VIX divergence. Most of the time VIX and SPX are inversely correlated. The rare times when they are not (i.e. both SPX and VIX increasing or both decreasing), is a tip to our model that we may be near a trend shift.
  • VIX sensitivity to movements in the SPX. Usually the VIX moves inversely to the SPX with a sort of beta multiple of around 3-5. i.e. if the SPX is down 1% for the day, VIX will usually be up 3-5%. When the VIX responds well outside that normal range (i.e. VIX up 10%+ or flat), that's a sign of a potential trend reversal on the horizon.
  • Shape of the VIX futures curve. Traders of VIX futures are well-known to be very sophisticated market makers and institutional investors that are making intelligent plays over the long run. 85% of the time, the VIX futures curve is in¬†contango which means that longer dated contracts are priced higher than nearer dated contracts. This make sense intuitively as just like option premium, the longer the time between now and expiration, the greater risk of some disaster upending the system. 15% of the time, the VIX futures curve falls into¬†backwardation. This is when nearer dated contracts are priced higher than longer dated contracts. This signals to the model that a near-term bottom is likely imminent, as sophisticated traders believe that the current risk event does not have lasting power.

When building the model, we took these and many other derivatives of VIX movement into consideration and carefully tested the patterns using machine learning and heuristics to distinguish those with predictive power against those that merely seemed like they had predictive power. This is what we call our proprietary anti-overfitting engine, and although no model can ever perfectly predict market movements, with this engine you can rest easy knowing the model is backed by the latest science and engineering. We leave human emotion at the door; the signals are generated 100% mechanically.

Performance

Vix Basic achieved an annual CAGR of 21.62% vs. 12.78% for SPX which we use as the benchmark. This represents a substantial outperformance of 8.84% per year. $100,000 invested in the model at inception would have grown to $1,223,900. Following the rules of all investment professionals, we must of course disclaim that past performance does not guarantee similar results in the future. However, our testing period covers many different market conditions, from the uber turbulent COVID-19 drawdown in Feb-Mar 2020 to the incredibly complacent 2013 and 2017 years. This lengthy period of analysis, combined with our proprietary anti-overfitting system, gives us confidence that our model has alpha.

Drawdown

Historically, the model had a maximum drawdown of -19.92% vs -36.01% for the SPX. This represents a substantial reduction in drawdown vs. the benchmark of 44.68%. When looking for a great model or market timing system, it's very important to not only consider absolute performance but also drawdown because investors should value risk-adjusted returns above absolute. The model's combination of absolute outperformance and smaller drawdown is exactly what savvy investors should be looking for in an actionable market timing system.

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