Volatility Strategies - Separating Fact From Fiction

Earlier this year I came across the website Volatility Made Simple. Much like our goal at Trading Volatility, Volatility Made Simple's goal is to help less informed investors understand and take advantage volatility ETPs in a manner that is similar to how large institutions trade volatility.

What is really great about Volatility Made Simple, is that at the end of each month the performance of various volatility trading strategies is recorded. As of the November update there were twenty different strategies on the list, and according to him, they represent the vast majority of volatility trading strategies of traders timing these products.

Below is his image which illustrates the November performance of strategies compared to XIV buy-and-hold.


The other nice thing is that he will occasionally write posts which independently examine each strategy in depth, identifying the exact trading rules and performing backtests to 2004 to see how they perform under a variety of conditions. This is useful to make sure that a strategy is not just optimized for ideal markets but can also perform well in more turbulent environments. In addition he also provides statistics such as percent winning/losing trades, average trade return, and sometimes the max drawdown percentage and Sharpe ratios. Below I will post several of the charts from his site.

It gets interesting looking at the ten year returns of these strategies. Looking at VIX & More's (by Bill Luby) VIX:VXV ratio strategy, we can see that a portfolio of $10,000 in 2004 grows to a portfolio of over $1,200,000 by February 2014 when following these rules. Chart below:



From $10,000 to $1,200,000 -- that's a a 12,000% return in 10 years! That's remarkably impressive.

A similar strategy offered by Market Sci, the Mean Reversion Strategy, takes our portfolio of $10,000 in 2004 grows to a portfolio of over $1,200,000 as well, although it takes a slightly different path to get there. Chart for Market Sci's below:



Then there is Trading the Odds's Volatility Risk Premium strategy which boasts growth of $10,000 to over $5,000,000 (50,000% gain) over the same time frame, beating Market Sci's returns by a factor of five:



And if that return isn't enough, there's the Optimized VRP Strategy, which fine-tunes backtested performance to turn a portfolio of $10,000 to over $10,000,000 in 10 years. This strategy is achieved with an average of just eight trades per year. Chart below:



Wow. So should we be issuing a scam alert? A 100,000% return over 10 years?!? GET REAL!! Too good to be true, right?

Except that these strategies are all valid. The average investor who just buys index ETFs or scours the stock market looking for the hottest stocks in a struggle to outperform the S&P 500 (or just break even) will completely dismiss these returns as impossible. But for me, VIX and More, Market Sci, Trading The Odds, Volatility Made Simple, and all the other people who have developed one of these volatility strategies, these returns are real (Note: None of these people are aware that I'm writing this, they have no connection with the Trading Volatility site, and do not necessarily agree with or endorse anything I'm writing). 

How do I know that these ridiculous returns are likely to be legit without independently verifying them for myself? Because our VXX Bias strategy is right in the ballpark with the leaders (performance summary for our VXX Bias strategy can be found here).



When you look at the return over the entire period it seems astronomical. But actually this just demonstrates the power of compound interest. A portfolio of $10,000 that grows at 90% per year over 10 years is worth $6,131,066.26, which is roughly what the best strategies return. The trick is being able to average 90% per year while avoiding major drawdowns.

When I tell people about my strategy and the returns that can be achieved, everyone skeptically asks, "Why aren't other people doing this?" The answer is "THEY ARE!

Volatility Made Simple tracks a handful of strategies that have been made public. From what I can tell, and as VMS points out, most of the strategies apply similar concepts. Each strategy has its own strengths and weaknesses and many struggle through the same conditions. Because of certain optimizations, some strategies manage to excel over shorter time frames under certain conditions. However, over the years it's easier to see the order of magnitude of difference among the different strategies. I'd argue that a blend of two or three of the top strategies would be the best way to reduce variation in returns, however this may not be cost-effective for smaller accounts.

There are many other confidential volatility strategies out there. They belong to the smart money managers and institutions who are making money hand over fist. And the best part is that it doesn't matter if it is a bull or bear market. 2008 financial crisis? Not a problem -- in fact, a good strategy flips to buy volatility to take advantage of a steep market decline.

The fact is, volatility ETPs are generally giant scams designed to separate unknowing investors from their money. VXX and UVXY are obviously horrible over the long term but can go up 10x in a matter of months. Inverse volatility (XIV) looks good most of the time but is prone to 80%+ drawdowns that can wipe you out. People who understand how these products work can exploit their flaws to generate giant returns. 

For people trading volatility ETPs at a loss or barely getting by, you have a problem. Given the amount of free and paid resources out there, there's no excuse for this. Here are some things you may want to consider:

1) Find a signal-based trading plan that matches your style and fits in with your financial objectives. Make sure the strategy has signals that make it easy for you to follow.

2) Strictly trade based on hard rules. This will allow you to avoid making emotional decisions and fighting the trend, and will maximize long-term results.

3) Understand that day-to-day, week-to week, and month-to-month performance can result short-term negative returns. Don't lose focus of the long term.

4) You will have losing trades. This is why we focus on process and probabilities, not short-term outcomes. What matters is the process and patience.

5) If you are not able to follow rules, don't trade. Sorry to say, but if you can't find the discipline you don't get the profits (and you probably shouldn't be trading at all).


(It also helps to understand how VIX ETPs work. For an overview you can read my free eBook, Fundamental Concepts and Strategies for Trading Volatility ETPs.)

Most of the strategies on VMS's summary are similar in that they assess market conditions at the end of each trading day to determine if a buy or sell is necessary. They are also similar in the number of trades per year, typically between 7 and 30, making these strategies fairly manageable swing trades which do not require the investor to be glued to a trading screen all day.

When it comes down to it, I don't really care which strategy you choose as long as you are successful. It's just time to stop being one of the many unfortunate who are on the wrong side of the trade.

If you'd like more information on the Trading Volatility Bias strategy please visit this link. Our Bias indicators are automatically emailed at the end of each trading day and our Bias change alerts notify subscribers whenever the Bias changes direction, making it easy to follow. Our subscriber services are available for less than $3 per day making it very affordable.

You can also take advantage of our free VIX Futures Data pages as well as our SPY Arbitrage and Pivot Point tools. And if you have any questions at all, feel free to reach out to me via the Contact page.




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Hypothetical and Simulated Performance Disclaimer
The results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under- or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown. Additional performance differences in backtests arise from the methodology of using the 4:00pm ET closing values for XIV, VXX, and ZIV as approximated trade prices for indicators that require VIX and VIX futures to settle at 4:15pm ET.



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2015 VIX Futures Expiration Days And Roll Period Lengths

As we get ready to head into 2015, I wanted to share the expiration date for each VIX futures month next year as well as the number of days in each roll period. Table below (source calendar).

Expiration Date           Roll Period Length
- Ending January 21:          22 days
- Ending February 18:        19 days
- Ending March 18:           20 days
- Ending April 15:              19 days
- Ending May 20:              25 days
- Ending June 17:              19 days
- Ending July 22:               24 days
- Ending August 19:           20 days
- Ending September 16:     19 days
- Ending October 21:         25 days
- Ending November 18:      20 days
- Ending December 16:      19 days




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VXX & ZIV Bias Indicators - October 2014 Performance Update

Th U.S. Stock market experienced a wild October, with the S&P 500 falling 9.8% from its peak on September 19 to a low on October 15, followed by a two week rally back to all-time highs. This extreme move was matched with a +170% gain in VIX as it rose to a three-year high of 31.06. Highlighting the swiftness of this move, VIX gained more than 10% on three consecutive days for the second time ever. Then, just as swiftly, it retreated with an unprecedented decline of -10% on three consecutive days.


Our Daily Bias indicators read these moves well and produced two great trades. A change to a positive VXX Bias signaled a buy in VXX on September 18 and a change to a negative VXX Bias on October 21 signaled a VXX sell for a gain of 21%. The move to a negative VXX Bias on 10/21 signaled time to move back to short volatility by buying XIV, a trade that is +7% as of October 31. Both of these trades helped us continue our quest to once again outperform the market this year.

Looking at year-to-date performance of the two VXX Bias strategies through October 31:
- Negative VXX Bias strategy: +21% vs +2% for XIV
- Positive VXX Bias strategy:  -5% vs -28% for VXX




Extending the performance time frame of the Negative VXX Bias strategy back to 2012:
- Negative VXX Bias strategy: +566% vs +411% for XIV





Turning attention to ZIV, the Positive ZIV Bias strategy was +1.3% in October bringing the YTD total to +4.8%.

Over the longer time frame back through 2011:
 - Positive ZIV Bias strategy: +391% vs 256% for ZIV.







Performance Data files: 
- VXX Bias: 200620072008200920102011201220132014
                - 2012-2014 (multi-year)
- ZIV Bias: 2011-2014 (multi-year)


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Hypothetical and Simulated Performance Disclaimer
The results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under- or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown. Additional performance differences in backtests arise from the methodology of using the 4:00pm ET closing values for XIV, VXX, and ZIV as an approximated trade prices for indicators that require VIX and VIX futures to settle at 4:15pm ET.


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Trading XIV & VXX Based on Data & Probabilities

You can't win in trading if your decisions are based on emotions, instincts, or hunches. Consistently successful trading requires objective and data-driven signals to identify trades with the highest probability of success. 

Fortunately, the market is always providing data-based clues on its trend as well as market sentiment. At Trading Volatility, our favorite indicators for trading both XIV/VXX and the broader market are the Bias and Spike Risk indicators. By taking a look the six month chart of these indicators (always posted on our Daily Forecast page) we can clearly see how sentiment has shifted over this time and the probabilities of a falling XIV/rising VXX have materially increased.

Our VXX Spike Risk forecasts the probability of a rise of 7% or more in VXX over the next two days. In the graph below you can see each day's forecasted Spike Risk (available at 4:30pm ET on the previous day) aligned with the percentage gain/loss of VXX.  There are three primary periods over the past six months:


1) Low risk (Apr 23 - June 10) - Spike Risk forecasts range between 15% and 35% while percent daily changes in VXX are mostly negative.

2) Mixed Risk (June 12 - Aug 19) - Spike Risk forecasts range between 16% and 58% in a choppy and indecisive market. Daily percent changes in VXX are mixed with big moves in both directions and a cluster of VXX gains in late July/early August while Spike Risk was elevated between 40% and 57%.

3) Moderate Risk (Sept 9 - today) - Spike Risk forecasts range mostly between 35% to 56%. VXX is seeing more up days than down days in its current trend, culminating with the most recent data point of a 56% Spike Risk with VXX +9% today. 



The readings from the Spike Risk forecast are reflected in our primary indicator for tracking trends in VXX and XIV, the VXX Bias. This is the key signal for us to trade with the trend and remain objective. Ultimately, the VXX Bias (left axis below) provides an indication of the directional pull of VXX. There are 3 distinct sections we can see in this chart as well. 


1) A negative VXX Bias during the low risk period (Apr 28 - June 16).

2) A mixed bias during out mixed risk period (June 17 - July 23).

3) A positive VXX Bias during the moderate risk period (Sept 19 - present)

You'll probably note some shorter periods of VXX Bias as well. Here we can highlight the fact that a positive or negative Bias forecast does not guarantee that VXX price will follow, however it certainly puts the odds in our favor. The signals keep us objective and help remove emotion from trading in a difficult market to set us up for long-term success. 

For full performance details of our Bias indicators visit this post. To go more in-depth on VIX, VIX futures, and our Bias indicators, check out our new e-book, available for free on Scribd.




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Link to Recording of Webinar with Bob Lang and Jay Wolberg

I was invited to join Bob Lang (options trading mentor at http://explosiveoptions.net, contributor to http://thestreet.com, and one of Jim Cramer's go-to technical experts on Mad Money) in a webinar yesterday. The recorded video has been posted online for anyone interested.

We had a great conversation, covering a wide variety of topics in 80 minutes. To help you find topics of interest, I've outlined our discussion along with approximate minute marks.

- Show intro (0:00)

- Bob's current market analysis (1:50)

- Into of Jay (10:15)

- Overview of Volatility (13:25)

- Role of actual market volatility in pricing of forward looking volatility (VIX) (17:18)

- What happens during  recent, brief VIX spikes which quickly revert; impact of QE (24:00)

- Common misconceptions of VXX (30:28)

- Reasons for large blocks of VIX calls (36:15)

- Reason why actual volatility may be higher than implied volatility (39:40)

- Reasons for a rising VIX while the market is rising (41.45)

- Likelihood of seeing a VIX in the 90s again (45:00)

- Reasons for current low VIX regime (47:50)

- Recent pattern of buying XIV on dips and likelihood of continuation of this pattern (51:05)

- Letting data guide trading decisions (53:25)

- XIV technical analysis -- importance of 200-day moving average (54:40)

- XIV indicators (57:30)

- Possibility of rally in XIV in today's market & levels to watch for Friday (1:00:10)

- Do VIX levels have influence on whether equities go up or down (1:02:00)

- Preparing for Black Swan events (1:03:45)

- Current decision making for trading XIV in market Friday (1:08:00)

- Signals for start of new rally in XIV (1:10:30)

- Why Thursday's move in XIV was an indicator that VIX was overbid (1:11:45)

- Tour of free resources at http://tradingvolatility.net (1:14:00)


If you are interested in learning more about trading options from a technical expert, check out Bob's website at http://explosiveoptions.net/ and follow him on Twitter at @aztecs99.



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The End of an Era for the Market

Before I get to today's post I'd like to mention that we recently released an e-book titled, Fundamental Concepts and Strategies for Trading Volatility ETPswhich is available for free download. If you are curious about how our Bias forecasts work and why they have been successful in identifying long-term trends under a variety of market conditions, be sure to give this a read. It explains the basic concepts of VIX and VIX futures as well as the main price drivers of various volatility ETPs, including the popular funds VXX, XIV, SVXY, UVXY, ZIV, and VXZ. I believe that the concepts outlined in the ebook are critical to understand if you're going to trade these products.

Now for today's post:

In today's market we saw VIX make a big +17.8% move up to 15.64. Its VIX futures ETF counterpart, VXX, gained +7.2% while the inverse VIX futures fund, XIV, lost 7.5%. Fortunately for us, our VXX Bias indicator moved to positive on September 18thsignalling the start of a rising trend in VXX and a falling trend in XIV. Since the signal was received VXX has gained 11.4%. The chart showing the past six months of our VXX Bias forecasts can be seen below, and is automatically updated daily on our Daily Forecast page.




The persistent substantially negative VXX Bias of 2012 and 2013 has given way to a choppy pattern in 2014 that is no longer friendly to shorting volatility. The +142% (2012) and 85% (2013) gains in XIV are behind us and now XIV is just +14% year-to-date with three months to go. This lagging performance was largely expected, as we outlined nearly six months ago

So far, this market pullback has been pretty ordinary since the S&P 500 peaked on September 19th. During the past couple years, any pullback that reached 4-5% off the all-time highs in the S&P 500 was bought and resulted in new highs a few weeks later. Traders have been conditioned to "buy the dip," with many thanks to the Federal Reserve's Quantitative Easing policy of putting $85-Billion per month into the market. 

However, as September draws to a close we start looking forward to October and the rest of this year for growth prospects in the equities markets. With October scheduled to be the last month of the era of QE3, the big question for me is whether the "buy the dip" model holds up in the absence of QE. Adding to that concern are warnings from major banking institutions which are publicly highlighting the idea that investors are taking excessive risks (IMF, BIS, BoE, FOMC). 

Did September 19th mark the top of this market run? Will volatility spike into the 20s, 30s, 40s, and higher values that we saw between 2007 and 2010? No one knows for sure (anyone who tells you otherwise is either delusional or lying), but it is important to note the possibility of a change here. We will continue to examine the data from our daily Bias indicators to guide our next decisions in determining whether the next move of the market is up or down. If you are interested in following along with us or learning more about our services please visit our Subscribe page.  


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Historical Context Of The VIX And VIX Futures Super-Cycle

VIX perked up in July as it rose 65% from a low of 10.32 up to over 17 in early August. This translated to gains of almost 30% in VXX, which tracks the daily movement of first and second month VIX futures.

Looking at our chart showing the past six months of VIX and VIX futures movement (from the VIX Futures Data page) there is a pronounced rise in all VIX futures over the month of July, bringing levels back up to those last seen in March.



Market participants have become accustomed to these VIX spikes and stick to a playbook of shorting volatility as it approaches 20. Recently this strategy has worked well but will it always work?

To help answer that question I've created an Archives page dedicated to historical data of VIX futures, containing a visual representation of VIX futures data over the past eight years to document the most recent VIX super-cycle.

On this page you can see how VIX futures traded from the calm market of 2006 through the chaos of 2008, all the way back to the calm of 2014. To give this data some context I've also added a selection of the more significant news events that have impacted the market. This allows you to see when various events happened and how they impacted the market. Some examples covered are:
  • inversion of the bond yield curve in 2006,
  • Bear Stearns downgrade & liquidity rumors,
  • signing of the $700B financial bailout bill (Emergency Economic Stabilization Act of 2008),
  • points when QE1, QE2, and QE3 begin and end,
  • events leading up to the Flash Crash,
  • Greek voters reject ruling parties in elections to put bailout at risk and possibly leave the Euro.

Some of the more enlightening graphs are:

Feb 2007 - Aug 2007 when mortgage defaults were rising as adjustable rate mortgage payments reset. The effect was a 50% rise in front month VIX futures over four months while in a contango term structure.




... Feb 2010 - Aug 2010 as Greece requested a bailout and fear of contagion spread across Europe.



... and Aug 2012 - Feb 2013 which shows the magic moment when the FOMC unveiled its open-ended QE3 program to place the most recent lid over volatility. 



You can view all of the graphs on the Archives page. If you are a Trading Volatility+ subscriber you get the extra benefit of using interactive graphs for your research. If you are interested in becoming a subscriber you can do so at the Subscribe page.




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Trading Around VIX Seasonality

We're now well into the second half of the year and XIV is sitting on a nice little gain of 28% YTD. But considering that the average annual return for XIV over the past two years is 114%, it is actually struggling a bit. So far this year the VXX weekly roll yield has averaged just -1.14% which will keep gains in check as illustrated by our XIV roll yield scatter plot (from my April post about reducing short volatility profit expectations). The current VXX Bias is only slightly negative, indicating a weak downward trend in VXX (weak upward trend for XIV) that is vulnerable to occasional spikes.
Over the past few weeks it increasingly appears as if the bulls may be losing momentum. Perhaps adding to the jitters is a chart of VIX seasonality that is currently making the rounds. I've included a chart below showing the average VIX from 2005-2013 compared to VIX in 2014.

From the chart we can see that July, August, September and October see increases in VIX (on average). While this is somewhat insightful, the chart is distorted fairly heavily by elevated VIX levels during the second halves of 2007, 2008, and 2011. The distortion is so great that even if we look at seasonality of the VIX for every year back to 1990 we still see the same seasonality trends. Yet in many of those years we saw volatility remain flat or decrease in the second half of the year. It is critical to remember that each year is unique and we must trade the data in the environment that we are in rather than trading the average of historical data. We will need to wait for each day to unfold in order to gather objective data about the state of the current market and trade accordingly.
At this time there is no reason to get too aggressive shorting VXX given the small weekly roll yield. Often the best trade when there is a weak or neutral Bias is to wait for a stronger trend to be established and I think that makes a lot of sense here. Taking smaller positions in XIV as long as the VXX Bias is negative would not be a terrible trade but positions really need to be watched in case we start seeing bearish momentum pick up. The line in the sand for XIV appears to be $44.50 (it closed Monday at $44.08). If it can get above that level and hold XIV could see some more gains here soon. 


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Objective Signals For Trading VXX, UVXY, and XIV

The market made an impressive run in May with the S&P 500 hitting new all-time highs at 1955.55 and the VIX touching 10.73. With each passing day during this run it seemed there was yet another article claiming that the market is too high or the VIX too low. With actual volatility of the S&P 500 over the past month just 6.42, a VIX in the 10-12 range makes some sense. But rather than speculate on where the VIX should be, the more profitable question is how to trade the volatility ETPs at these levels.

It's dangerous for investors to speculate on where the market will go next without a solid set of objective tools to guide decision making. At Trading Volatility we rely on our proprietary Bias and Spike Risk indicators to provide us with objective information about the likely direction and momentum of volatility ETPs such as VXX, UVXY, TVIX, XIV, SVXY and ZIV.  The daily signals from our indicators make it possible to substantially outperform the market and today I'll provide a closer look at these signals.

VXX Bias Forecast
After the close on each market day our algorithms generate the Bias and Spike Risk forecasts for the following day and publish the data on our Daily Forecast page. We track all of our forecasts and compare the values to the actual movement of VXX, as shown in the graph of our forecasts over the past six months, below.



Here I've highlighted two distinct periods. The first is from Jan 24th to April 28, a three-month period in which the VXX Bias forecast (the blue line, using the left axis) stayed slightly negative with a handful of moves to a positive Bias. This block of forecasts provides us with an indication that there is no real advantage in shorting VXX (or buying the inverse, XIV) given that there is no directional Bias to help us in our trade. While VXX (red line, using the right axis) did see some price spikes during this time, they were short-lived as the Bias failed to remain positive.

Looking at the second period from April 29 to June 11, the VXX Bias was more solidly negative with Bias reading between -1 and -2. These readings told us that the wind was at our back to short VXX (or buy XIV) as VXX fell over 25% during this time. As of the evening of June 11, the VXX Bias jumped back up toward zero remaining just slightly negative, to once again let us know that it is time to be a bit cautious shorting volatility.


VXX Spike Risk Forecast
The VXX Spike Risk forecast provides us with information on the probability of a VXX spike (for our purposes, a "spike" is defined as a move of 7% or more over the next two trading days). As with the VXX Bias, we track our daily Spike Risk forecasts against the percent change of VXX for each day. The graph below captures forecasts vs actuals for the last six months.



We've only seen one period of sustained VXX Spike Risk (blue line, using the left axis) above 50%, which took place in late January/early February when we saw the big upward +30% move in VXX.  Other than that we've only seen a handful of forecasts reaching above 40%. Looking at the recent period from 4/22 to 6/10 you can see a string of low Spike Risk forecasts below 28% and as low as 16%, indicating time to be a bit more aggressive in shorting VXX. This worked out very well as the price of VXX fell on almost every day during this period (red line, using the right axis). For June 12 we saw a Spike Risk of 49% on a day when VXX gained 6.5% intraday, and today's forecast (June 16) was back up to 48%, once again indicating that we need to be more cautious.


The market provides subtle clues for what the it might do next. As you have now seen, we incorporate these clues into our algorithms to generate what we believe are the best indicators available. If you find yourself struggling in this market check us out. To learn more visit our Subscribe page or drop us a line via the Contact page.


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The Quest To Outperform The Market

Chances are, if you're an active trader in this market you are struggling to make money. In reality it's a tough game, one in which hedge funds and mutual funds constantly underperform the market.  In 2012, 88% of hedge funds and 65% of mutual funds underperformed the S&P 500 benchmark. In 2013, the hedge fund average trailed the S&P 500 for the fifth straight year with a 7.4% return, 23 percentage points below the S&P 500.

Why do so many professionals and individual investors lose money? Because in order to be successful in trading you need both a good plan and the discipline to execute against the plan. Without both of these a trader will fail to make money consistently.

While we can't really help you with the discipline, we can help you with the plan. We focus most on trading two securities, VXX (the "volatility futures fund") and XIV (the "inverse volatility futures fund"), based on the direction of the fund's built-in Bias. The Bias is our proprietary way of measuring the current directional force on the fund and is primarily based on the price structure of VIX futures and the internal mechanisms that the funds use to manage their holdings. As these values change each day we measure and report on the Biases in our Daily Forecasts so that we know both their direction and magnitude.

With that information, we apply the simple strategy of buying XIV when the VXX Bias is negative, or buying VXX when the VXX Bias is positive. Trading in the direction of the Bias is critical since it can impact the price of the fund by as much as 10% per week. Trading in the direction of the Bias allows traders to take advantage of the funds structure and can provide an edge in trading.

Over the past couple years, XIV has become a popular fund to own with annual returns of 142% and 85% in 2012 and 2013, respectively. But this is not a fund to buy and hold since it is prone to 80%+ losses if the Bias reverses (see XIV: When a "Sure Thing" Goes Bad). You can see in the table below that while the average annual return of XIV is 46%*, it experienced several ugly years when there was an unfavorable Bias. Rather than suffer through these losses, XIV can be sold whenever the VXX Bias is positive to help reduce drawdowns. This "Negative VXX Bias" strategy has been shown to substantially outperform XIV in 6 of the past 8 years, with an average excess performance of 48 percentage points (far right column, below).


% Gain / Loss By Year
YearXIV"Negative VXX Bias" Strategy"Positive VXX Bias" StrategyExcess performance over XIV using "Negative VXX Bias"
200673%60%-15%-13%
2007-51%-34%13%17%
2008-71%-8%128%63%
2009103%116%-9%13%
2010135%284%42%149%
2011-47%45%61%92%
2012142%216%11%74%
201385%74%-30%-11%
Average46%94%25%48%


A look at each year's performance of the "Negative VXX Bias" strategy shows that while it is still vulnerable to losses, overall the strategy has done exceedingly well compared to the alternatives. A comparison of the annual returns of XIV vs the "Negative VXX Bias" strategy is better visualized below.




You can get a feel for how the strategy performs on a day-to-day basis by looking at the each of the performance data files (**links located at the bottom of this post). In these files you can view a graph of the daily value of a portfolio employing each strategy. The chart below compares the "Negative VXX Bias" strategy to XIV during 2011. Note the flat blue line which illustrates that XIV was not owned in the "Negative VXX Bias" strategy during the time XIV experienced steep losses because there was a positive VXX Bias.





The performance data files also contain the forecast VXX Bias values, entry and exit points, and gain/loss data including a histogram of trades. Below is a summary of trades each year for the "Negative VXX Bias" strategy.

Number Of Trades Per Year For Negative VXX Bias Strategy
Year# of TradesWinnersLosersAvg Trade Gain/Loss
200612664.94%
20071459-2.43%
20081376-0.33%
200911658.05%
201075323.34%
201110374.54%
2012115612.51%
201315874.27%


Given the size of gains & losses I've discussed so far it should be clear that these strategies typically align with traders who have a relatively high tolerance for risk. They are not for everyone and they are certainly not for anyone who does not pay attention to the changing Bias of the funds. However, if you're a trader who has decided that these types of funds are right for you, we would love to provide you with the tools to assist in your analysis and decision making process.

In addition to tracking these Biases on our website, we can also send email alerts to let subscribers know when the VXX Bias has changed direction. To learn more about the services we provide you can check out our Subscribe page, or drop us a line via the Contact page. You can also chat with us on Twitter at @tradevolatility if you like. We're here to help and answer any questions you might have about the world of volatility!


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*Daily prices for VXX and XIV prior to fund inception have been derived from existing VIX futures data. Backtests use each security's 4:00pm ET closing value as an approximated trade price for indicators that require VIX and VIX futures to settle at 4:15pm ET.

**Data files: 20062007200820092010201120122013, 2014


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Hypothetical and Simulated Performance Disclaimer
The results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under- or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown. Additional performance differences in backtests arise from the methodology of using the 4:00pm ET closing values for XIV, VXX, and ZIV as an approximated trade prices for indicators that require VIX and VIX futures to settle at 4:15pm ET.


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VXX Bias Forecast Performance Review, 2014 Year-to-Date

With one third of 2014 now behind us, it's a good time to take a look at year-to-date performance of our Bias strategy. The U.S. stock market has been mixed so far this year (through May 9, 2014) with the S&P 500 index gaining 1.6%,  the Russell 2000 down 4.8%, and the NASDAQ 100 down 1%. The VIX has lost 5.8% YTD although it has seen some wild swings already, gaining 56.3% in early February before returning back to where it started.

At Trading Volatility we focus on trading of VIX ETPs with most attention on VXX and XIV. Today we'll review the year-to-date performance of the VXX Bias forecasts, which are generated after each trading day at 4:30pm ET.
- For those of you who are unfamiliar with our daily Bias forecasts more information can be found on the Daily Forecast page.
- For backtested performance of the Bias strategy dating back to 2006 please see this post.

VXX Bias Indicator Performance, 2014 YTD (Data sheet with trade and performance details)
As usual, we'll review the performance of the indicators in two halves:
1) the "Negative VXX Bias" strategy which involves buying XIV whenever the VXX Bias is negative, and
2) the "Positive VXX Bias" strategy which involves buying VXX whenever the VXX Bias is positive.

1) Negative VXX Bias Strategy
The VXX Bias forecasts are designed to help traders identify the direction and magnitude of any headwinds/tailwinds in VXX and XIV that arise from the structure and momentum of the underlying VIX futures securities. So far this year the Bias forecasts have identified a key change in market structure in early January to give traders a chance to exit positions in XIV before the full 29% drawdown (see graph below). Confident investors sparked a stock market rebound to keep that drawdown contained, but we've seen a mostly sideways/choppy market with a neutral VXX Bias for the majority of the year. Long-time readers of our posts will know that a neutral Bias makes for little or no trading edge in VIX ETPs, making for a more difficult trading environment. However, in late April & early May we've seen the VXX Bias grow more negative and exit the neutral zone to drive new lows in VXX and drive price higher in XIV.
- As of May 9, XIV has returned 0% YTD vs +3% with the Negative VXX Bias strategy.




2) Positive VXX Bias Strategy
We've seen several moves to a positive VXX Bias this year but only one instance has lasted more than a handful of days. In the January instance the VXX Bias remained positive for 13 days, with VXX gaining over 30% before finally closing out a 10.8% gain. Most of the remaining VXX trades have ended with small losses in typical VXX behavior. 2014 has once again demonstrated that while VXX can see good short-term gains, they tend to be fleeting when the Bias quickly returns to negative.





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Hypothetical and Simulated Performance Disclaimer
TThe results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under- or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown. Additional performance differences in backtests arise from the methodology of using the 4:00pm ET closing values for XIV, VXX, and ZIV as an approximated trade prices for indicators that require VIX and VIX futures to settle at 4:15pm ET.


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