The CBOE Volatility Index (VIX) can be used as an analytical tool to identify entry and exit opportunities, or periods when market risk is likely to be higher or lower. This information is especially useful because it is not just another iteration of a price-and-time study, but is derived from investor expectations for near-term volatility, according to many options trading articles.
The VIX is obviously useful as a way to analyze the stock market indexes, but in this article I will show that it can also be used to help identify opportunities in the intermarket environment.
See Part I of this series on trading the VIX.
The VIX has a propensity to channel, which can make analysis very easy. Channeling markets (like trending markets) are predictable, and can be very profitable when they are consistent and extended. Technicians always struggle with the transition from a channel to a trend and vice-versa, so the VIX’s tendency to channel for long periods is extremely convenient for a technical trader.
Within a channel, support and resistance levels become triggers for entries and exits, or as warnings that risk is rising or falling. (Learn more about support and resistance analysis.)
In the video below, I will walk through how those signals compared to the actual price action on the SPDR S&P 500 (SPY).
We recommend that you spend some time looking through the historical charts of the VIX and comparing it to a chart of the SPY or S&P 500 index (SPX). It should be clear how the VIX could have been used to identify buy and sell signals.
Even when volatility is elevated beyond historical levels, these support and resistance bounces can be helpful.
In the video below, I will illustrate how this analysis can be used within the current high-volatility market environment. (Learn how to use covered calls in a high-risk market to reduce losses and make profits.)
Although the VIX is based on the volatility of the S&P 500 index options, it can be useful as a general measure of investor sentiment in the intermarket environment.
For example, forex traders are aware of a periodically strong correlation that the USD/JPY exchange rate has with U.S. equities. The bullish trend on the VIX in the first and second quarter of 2009 has shown that USD/JPY shorts are at risk, and that an extended trend to the downside is unlikely.
The VIX can also be used to help forecast and analyze yield trends, bond prices and commodities. In the video, I will cover an example of this kind of intermarket analysis.
See Part III of this series on trading the VIX.
John Jagerson is a contributor to LearningMarkets.com. This article originally appeared on the Learning Markets Web site.
