Using VXO to time the SP 500
Here’s a potentially useful indicator for timing the S&P 500 on a weekly basis. Consider the following two strategies:
1. Hold SPX when VXO rose the previous week, else hold cash.
2. Hold SPX when VXO declined the previous week, else hold cash.
Here’s a chart comparing the two strategies since 1986 (not adjusted for dividends).
Not bad. Risk/reward has historically been better when VXO rose the previous week. I guess this makes sense from a mean reversion standpoint. It seems to me this indicator works best when market volatility is high (e.g. late 90′s/early 00′s and financial crisis-present). The indicator wasn’t as valuable during the early 90′s and 04-07 period.
The strategy experienced a number of big losses in this backtest. This happened when SPX fell sharply several weeks in a row while VXO continued to break out to new highs. A filter could be added to the above strategy to filter out some of the potentially big declines. One effective filter would be to avoid holding SPX when VXO closes the previous week more than 20% above its 5 week moving average. The parameters for the filter seem fairly robust. Setting the % too low will weed out a lot of profitable weeks while setting it too high will fail to avoid many of the worst losses.
The chart below compares two strategies:
1. Hold SPX when VXO rose during the previous week AND VXO closed the previous week less than 20% above its 5 week average, else hold cash.
2. Hold SPX when strategy #1 is not in play, else hold cash.
A number of large losses are filtered out without sacrificing too much performance in other time periods.
Here are some stats for the whole period and for 2009 to present.
All data is from Yahoo Finance. Using VIX would have generated similar, though not quite as good results. You can download an Excel copy of this backtest here: VXO SP500 Weekly Strategy
Posted on January 15, 2013, in Other. Bookmark the permalink. 16 Comments.
Good stuff!
On your excel copy of backtest, columns B through I (8 columns) are missing. Just wondering if I can get a spreadsheet from you that includes those columns,…for entering VXO, etc. Very interesting strategy, thank you for sharing your work. Regards, Jim P.
Hmm…it’s not missing when I open the file through the link. What version of Excel do you have? Maybe I need to post an XLS version instead of XLSX.
Figured it out, my mistake, all columns are there, thanks again. Regards, Jim P.
Your charts would look much better and produce smaller files sizes if you used lossless png compression instead of lossy (and grubby-looking) jpg compression.
Ha, thanks for suggestion. I’ve never quite got that right. WordPress kills the picture clarity if it’s too large.
Yeah, definitely save as .png WP likes them much much more than .jpg
Word. I’ll definitely try that out for the next post (maybe even fix this post if I’m not too lazy).
Good strat thx for sharing
http://tinyurl.com/bh2ayse
Al
Thanks for sharing, Mike. You’ve probably noticed that Michael Stokes has written about it on his MarketSci blog.
I was wondering how this strategy does if, instead of cash, one were to go short.
Playing the short side with this strategy only works well during decent corrections and bear markets. I wouldn’t advise it without testing some possible filters to improve the risk/reward tradeoff. The results above also don’t include dividends, which would further reduce returns from the short trades.
Hey Mike.. really nice the idea of VXO.. nearly nobody cares about it.. Have you got some ideas for the intraday session, both on SPY, e-minis, or VIX etps? It’s only cause I’m thinking a lot about it referring the equity I don’t use in the intraday hours, because of my “nighly method”. Just write me on marko.marco@hotmail.it just for doing something together putting some ideas together
Congrats on continued solid posts on quantitative trading.
One minor suggestion for your consideration: use log for y-axis on plots (especially price and P&L charts), rather than linear. This makes visually comparing values easier across varying scale, as percentage changes are scale-invariant on the non-time axis.
Thanks, appreciate it.
I usually use log scale for the y axis or a constant trade size for my charts. Either of these methods does a good job showing percent changes over various time periods. I agree that linear scale charts can make it difficult to do this, especially over long time periods with volatile series.
Pingback: More on Using the VXO to Time the S&P 500 « MarketSci Blog
Pingback: What I’m Reading This Weekend | System Trading with Woodshedder