Using VXO to time the SP 500, part 2
Happy New Year!
This is a follow-up to the popular post I did last January on using weekly closes in VXO to time the SP 500. In that post I showed it has historically been much more profitable to own the SP 500 following weeks when VXO rose vs. weeks when VXO declined. Beautifully simple.
In this post I’ll add another indicator to the timing model. Just a bit more complexity. This indicator will show that many weeks following a VXO decline are really not that bad. We can separate those that have tended to decline from those that tended to rise.
The indicator I’ll introduce is an acceleration measure based on SP 500 weekly highs and weekly closes. First I calculate each week’s high divided by the previous week’s close. The final indicator just looks at whether this number increases or decreases from week to week.
In other words, is HIGH t/CLOSE t-1 greater than or less than HIGH t-1/CLOSE t-2 ? I’ll refer to the high divided by previous close as H/C in the rest of the post.
In the chart below, you’ll see three equity curves. One invests in the SP 500 whenever VXO declines the prior week. The other two will distinguish weeks with an accelerating H/C vs. weeks with a decelerating H/C.
Nice. As you can see, the index tends to fall when H/C accelerates and rise when H/C decelerates. We are also closer to having a decent short setup based on times when VXO declines and H/C accelerates. We can make the short trade more appealing by simply requiring the previous week’s VXO close be above 19. A VXO close of 19 works well but other values around it work well too.
The below chart shows profit curves for investing in the index when VXO declines, H/C accelerates and either VXO closes above or below 19 the prior week.
Finally, let’s combine all long and short trades together. Here is how the final model rules could work.
Long SP 500 when either VXO rose or when BOTH VXO declined and H/C decelerated.
Short SP 500 when VXO declined, H/C accelerated, and VXO closed greater than 19.
Cash when VXO declined, H/C accelerated, and VXO closed less than 19.
Below are equity curves for buy and hold, a long only model, and a long/short model. Not bad.
Cheers and best of luck to you in 2014!
**Technical note: All data are from Yahoo finance and exclude dividends, commissions, fees, slippage, etc. etc.
Update: Here is an Excel file with data and calculations for the last chart. Enjoy! SPY VXO Weekly Strat Part 2
Update2: Here are some stats that were requested.