Saturday, January 27, 2007

Absolute vs. Relative Highs and Lows in the VIX

Price Headley, founder of BigTrends.com, is one of many who maintain that the best way to think about the VIX is not in terms of absolute numbers and a multi-year lookback period. He recommends that traders focus instead on relative highs and lows over the course of recent trading ranges. Specifically, Headley favors 20-bar Bollinger bands with 2 standard deviations and opines,

"...forget about where the VIX has been in years past, and instead focus on getting the most of out the VIX using relative bands like Bollinger Bands. You can see that when the market tagged these lower boundaries for the VIX, as in mid-December and mid-November, then the market is ready to correct or at least go sideways. This follow-up information will prove invaluable as a contrarian, being willing to sell the market when the VIX is at its lower band, while being able to get more aggressive when we see fear spikes to the upper band. "
For the record, I am a strong believer in applying Bollinger Bands to the VIX and am of the opinion that Bollinger bands can provide solid trading setups not just for the broader markets, but for the VIX as well.

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