Prediction Wizard

VIX:

Our next indicator that we use for general market status identification is the VIX, the volatility indicator. It is also called by some traders as the Fear indicator, that could be misleading.

It measures the market’s expectation of future volatility appearing in the stock index option prices.

To further clear the interpretation of the VIX indicator I would like to suggest reading the following VIX – related documents, published by CBOE. (Chicago Board of Options Exchange) that could be downloaded from our WEB portal server:

http://www.predictionwizard.com/index.php?mid=88&parent=198

The following chart presents the long-term relative performance of the S&P500 index and the VIX. The chart is a monthly chart. I also added the SMA10 and WMA10 for the VIX.

We can conclude some of the following:

- The maximum value in the VIX is market specific and it is very hard to estimate in any circumstances.

- The minimum value of the VIX is usually between 10 – 16 range.

- The minimum value within the VIX is not necessarily the maximum value point in the S&P index.

- The direction of the SMA10 and WMA100 (Ten period Simple Moving Average and Ten period Weighted Moving Average) might be more telling about the possible future direction of the index itself.

- There are market periods, when the Inverz relationship does not necessarily apply.

(For example such periods were: Nov 2008, Dec 2008, Jan 2009…)

This is exactly what described in the above mentioned article (Myth #2, We need to differentiate between Fear and uncertainty.)

There are a lot of articles, public research materials covering the VIX and its usefulness.

The Weekly, Monthly VIX might be important for swing traders and investors.

For active traders, the three most important application of the VIX might be the following:

1.

Potentially at Minimum VIX extremes, we can be more confident about future direction and might increase our position size accordingly.For example when we have a 5 Days Maximum in the VIX intraday, than we increase the Long position (If playing long), and if we have a 5 Days Minimum in the VIX, than we increase the size of our short position (If playing short)

2.

The VIX value itself could be used as an excellent tool to calculate our basic position size. Our position size depends on market status / setups, the WIN probability of the predictions that we are playing and as a default it depends on the expected volatility.As a general rule the Daily range of the S&P500 index is about VIX / 16 [%] This means, that for example having a VIX value of 16, we can expect the average Daily market range as 1%.Having a VIX value for the previous market Day as 80, than we can expect the coming daily range to be about 5% (80 / 16)

3.

Few VIX – related settings work so consistently as the following setups:According to some research the deviation from the SMA gives us a better edge than the VIX level itself.If we have the Daily closing level of the VIX more than 5 – 7% above the SMA10, than the win probability of a Long position is considerable better than 50%.If we have the closing level of the VIX more than 5 – 7% below the SMA10 of the VIX, than the WIN probability of the short position is considerable better than 50%Some traders even use these or similar setups for regular trading.According to Connors this edge works in a number of different time-frames.

Volume:

Volume is an extremely important factor in trading and trading decision making.

It is almost as important as the price chart itself.

There are a lot of indicators, derived from the price itself.

All of those indicators have the common basis and only the presentation of the indicators different we do not get much additional benefit to our trading just by adding more price – related indicators, due to the high correlation between those and overlapping commonality.

The volume and the price has no direct correlation, it could be handled as a separate aspect of the market status carrying additional information.

From the distribution of the price levels during any time-frame and the corresponding, but different distribution of the volume we can conclude a lot of things about the market status.

We can identify:

- What price levels or price range do we have the majority of the volume.

- During the time-frame we are viewing we have one more or less Bell-shaped price / volume distribution or we have multiple peaks, which suggest shifts during the time – period we are looking at.

That means high volume appeared for one specific price range, than price quickly shifted, and high volume appeared again in the new price range.

- The market is accepting or rejecting a new price range as it is moving.

Volume in any asset is relative. We can say something about Volume only if we know the volume in that asset for the previous N period.

For example to say that SPY volume is low or high we need to know what is the average volume during the past 1 month, 3 month, 12 month, 24 month, 60 month… depending on our time-frame.

There are four different situation if we want to use both price and volume during our trading:

1.  Increasing Price and Increasing Volume.

2.  Increasing Price and Decreasing Volume.

3.  Decreasing Price and Increasing Volume.

4.  Decreasing Price and Decreasing Volume.

The best setup is when increasing volume accompanying increasing price action.

But that does not necessarily mean, that lower volume up moves have less than 50% probability to continue upward. The market can move up for extended period even on lower volume.

If we add another specifics to the equation, the Volume at Bid and the Volume at Ask, than we get 8 different situations instead of the above mentioned four situations.

Though a bit more complex, but that could give us better readings about current market status.

Within our trading supporting system we often trade the NASDAQ100 index – related assets.

To support our trading decision we also use Volume.

For each and every component of the NASDAQ100 we know what trade occurred at what price level, and occurred at the bid or at the ask.

We know, that the specific trade was a relatively small size trade a medium size trade or a big trade. (We use the notion of average trade size and a proprietary mechanism to make the differentiation between Small, Medium and Big trades.)

According to some of our research, we know, that small trades and medium trades have no predictive capability for future market movement, but big trades have a little bit predictive capability.

That does not mean we will never go against some big trades, if other market conditions support, but we want to know how the big players of the market are doing on different time-frames.

Volume profile might be very important for investors.

Some of those companies hiding in the background for months and years at some point might get into the reflector light. Volume increases could be used to filter out these companies and find real great trading situations.

Big volume surges rarely happen without real reasons. The relative change might be bigger if the Average volume in the past was small, and smaller if we are looking at more established companies with higher average volume.

Volume analysis slightly different for indexes and for individual companies.

Similar to the VIX, the Volume is another indicator, that could be used to estimate the range of movement during our time-frame. Higher volume increase the probability of higher trading range.

To highlight this feature I would like to present the following statistics, updated a few weeks ago.

1.  The correlation of the Daily range with the Daily Volume is 0.7219

2.  The correlation of the First 30 min Volume with the Daily Volume is 0.7273

3.  The correlation of the First 30 Min volume with the daily market range is 0.446

The behavior, movement of the indices are extremely important for both index traders and for traders of individual stocks and other assets.

The described indicators could be good starting point for all market participants.