Saturday, February 24, 2007

VIX Weekly Sentiment Indicator Update

Last week I introduced the VIX Weekly Sentiment Indicator (VWSI) as a gauge of likely VIX activity over the coming 1-4 weeks. Following my initial post on this subject, several readers asked for additional details about the inputs into the VWSI and how the VWSI readings are calculated. This seems like a good time to set some expectations.

First, my intent is to update the VWSI each weekend with some pithy remarks about some reasons for the current reading as well as thoughts around how one might employ various VIX option strategies when the readings reach extreme levels. I would consider ‘extreme’ readings to be >+5 or <-5, but believe that readings in the +3 to +5 and -3 to -5 ranges to be such that they can be also be traded profitably. When we see readings of this magnitude, I will go into more detail.

As far as the calculations are concerned, I have no intention of publishing the exact formula, but suffice it to say that the most heavily weighted inputs are several simple moving averages. Typically, if you see readings of >+3 or <-3, it is usually a function of extreme divergences between the current price and the SMAs – and with it an expectation that the VIX will move back in the direction of the SMA reading over the course of the next 5-10 days. I actually provided considerable detail about this last week.

I should also note that I have wrestled with the idea of how much the content in this blog should be presented as an informational resource and how much, if any, it should be geared toward specific trading strategies and setups. My strong preference is for an informational approach; while I may discuss trading approaches or even specific positions I may be taking in the VIX or in other securities, this will definitely be the exception rather than the rule. I am primarily a discretionary trader and do not have any desire to disclose the rationale for my entries and exits, except on an occasional basis, generally to illustrate a point.

Those interested in an example of one of the mechanical systems I use for trading are encouraged to look at my Portfolio123 live portfolio, which I will update every Sunday.

Finally, to address the title in this post: the VWSI temperature gauge reading for the week ending 2/23/07 is 0, down from the +1 level of the previous week. While some averages (e.g., the 20, 50 and 100 day SMAs) are at all-time lows on an absolute basis, the relative numbers keep the VWSI in the middle of the neutral zone at the present time.

(Note that in the above temperature gauge, the "bullish" and "bearish" labels apply to the VIX, not to the broader markets, which are usually negatively correlated with the VIX.)


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