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VIX Lines
VIX Lines Volatility lines with predictive validity
User Guide Version 1.3 Basic Edition
www.trade-with-me.eu Created by mirko@trade-with-me.net
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VIX Lines Content 1
Theoretical Background of VIX Lines, the volatility lines with predictive validity ....................... - 1 -
2
Getting started ............................................................................................................................ - 2 -
3
4
2.1
Current situation ................................................................................................................. - 2 -
2.2
VIX-Lines components ......................................................................................................... - 3 -
2.3
Installation ........................................................................................................................... - 3 -
2.4
Arranging the charts ............................................................................................................ - 4 -
Learn to “read” the VIX-Lines ...................................................................................................... - 6 3.1
Major VIX Line ..................................................................................................................... - 6 -
3.2
VIX support and resistance Lines......................................................................................... - 7 -
3.3
Trading example .................................................................................................................. - 8 -
3.4
Times to trade ..................................................................................................................... - 8 -
3.5
Different timeframes ........................................................................................................... - 9 -
Workflow and Radarscreen ....................................................................................................... - 11 4.1
The workspace................................................................................................................... - 11 -
4.2
Dealing with huge number of symbols.............................................................................. - 12 -
4.3
Technical details ................................................................................................................ - 14 -
4.3.1
Bars back and CPU power.......................................................................................... - 14 -
4.3.2
Errors ......................................................................................................................... - 14 -
5
Work in progress – please provide your input .......................................................................... - 15 -
6
Me, the author .......................................................................................................................... - 16 -
7
Disclaimer: ................................................................................................................................. - 17 -
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VIX Lines 1
Theoretical Background of VIX Lines, the volatility lines with predictive validity
One of the best known bands in financial analysis is maybe the Bollinger Band. It is important to note, though, that the Bollinger bands do not have predictive validity (Bollinger 2001). Similarly, no claim can be made that a desired percentage of points fall within the Bollinger bands. Bollinger bands has been found useful in technical analysis to trade breakouts from Bollinger bands, assuming that if an asset breaks out of the Bollinger band range a new trend has been started. A couple of successful strategies are based on the Bollinger band breakouts (like “Aberration” from Keith Fitschen just to mention one). The VIX-Lines volatility band is used in the opposite to the Bollinger band because it is assumed that nearly no point falls out of the band – or with other words that more than 99,9% of the points are in the range of the band. If we assume that the price of an asset is randomly distributed we can conclude that an endless number of random walk prices results under simplified settings in a Gaussian normal distribution (this is called “Brownian motion”). Autoregressive conditional heteroskedasticity (ARCH) and generalized autoregressive conditional heteroskedasticity (GARCH) models are based on this idea and get used by financial institutions and hedge funds to predict future volatility moves since nearly 30 years (Engle 1982 / Bollersley 1986). Most of the algorithms developed by those models are based on the volatility of a single asset and tested via a null hypothesis on a confidence interval of α = 0.01 resulting in the popular 99% coverage level. This classical approach will deliver the answer if the algorithm is predictive for a specific asset (e.g. Algorithm xy is predictive for Gold futures) but is not providing an idea what has to be done to get a generic Algorithm with predictive validity for all assets. Via metaanalitic formulas (like Cohen's ƒ2 or Fisher’s Z) it is possible to determinate a common effectsize which tells the developer of the algorithm what has to be done to get predictive validity for all assets. The Metaanalysis will not only deliver a single digital answer (as the null hypothesis does) but helps to find the degree on which an algorithm has to be fine-tuned to fit a broad range of assets. VIX-Lines have predictive validity for all kind of Futures, Equities and Forex. Further research details will be published in the near future.
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VIX Lines 2
Getting started
Learn about why trading with a system is important, the components of VIX-Lines and how to arrange your charts in this chapter. 2.1
Current situation
Most Stocks, Futures and Forex markets have rhythmic pattern with waves of buying and selling. These waves do not always have to do with underlining fundamentals, especially in times without new fundamental information. Technical analysis is the common tool to analyze these patterns. Classical technical analysis tools which were popular in the late 80’ of the last century are not always the best solution to understand nowadays market movements made by modern hedge funds using high tech trading algorithms. Most professionals agree, that trader need to have a proven system to be successful in the markets. If individual traders let their trades get dominated by Fear and Greed without a system there is a high probability to loose. Fear and Greed are no good consultants if it comes to the point to make a trading decision. Fear and Greed may influence the mind of a trader and move him to a point where he is not able to make thought through decisions. If a trader does not have a system where he can stick to - the probability to get dominated by Fear and Greed is much higher because the trader never knows when to act in which direction and get lost to emotions. Resource rich institutions do not have to deal with so many emotions; they invest thousands of dollars in research teams to gain scientific statistical based advantage against the “average traders�. If they have discovered once that something has a statistical advantage they will trade it again and again, knowing that in the end they will make their money. VIX-Lines are offering a scientific proofed indicator pack providing insight information on hidden volatility lines which are invisible without tools. In the end, the business of trading depends on your ability to make well-balanced decisions at times when decision making is the hardest. A proven successful framework can help to make better decisions. This is the reason why you should check out the ability of VIX-Lines. VIX-Lines make the invisible volatility lines visible on the chart and can give you the advantage you may need to be successful in the market.
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VIX Lines 2.2
VIX-Lines components
VIX-Lines are a whole system which is designed to assist you to take better trading decisions. The VIXLines system is purely volatility based and has shown a predictive power from 2 to 3 bars in numerous statistical tests on Stocks, Futures and Forex. Name Major VIX Lines VIX Support and Resistance (dotted lines from VIX1 to VIX8) Overbought Oversold dots
Feature Volatility based support (blue) and resistance (red) lines Support and resistance lines.
Benefit Show immediate strong support and resistance Shows the invisible volatility support and resistance lines
Show extremes
Provides additional guidance
Figure 1: Components of the VIX-Lines System.
VIX-Lines: Early recognition of hidden Support and Resistance lines and market trends due to predictive validity Scientifically proven system Supports all timeframes and all assets (Equities, Futures, Forex) Many tradingpacks have too much information, VIX-Lines has clear a structure VIX-Lines paint lines into the future. No lagging indicator (like moving averages) enables you to act faster Put a distance between you and the crowd, try VIX-Lines. 2.3
Installation
1. Download the Workspace from http://www.trade-with-me.eu/VIX-Lines.tsw; press the strategy network button. 2. On the Radarscreen Template you have to remove the unnecessary columns by right-clicking with the mouse on the column header and removing the little points. You only need the two last columns - “OBOS” and “VIX-Line” - in Radarscreen. (Note: It looks that it is not working another way because the formatting is not saved).
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VIX Lines 2.4
Arranging the charts
Before you start you should arrange the chart that you can see the relevant information. VIX-Lines were designed to give you a clean workspace and a fast overview without too much unnecessary information.
Figure 2: Wasted space on the Chart due to automatic scaling
This picture shows how it looks like if you have chosen to automatically scale the range based on the dates on the screen. The issue on automatic scaling is that it shows everything without focusing on the most recent bars. For this reason you need to adjust your chart.
Figure 3: Background Dragging
Hitting the “Background Dragging” button will change your cursor into a little hand. You should move the hand on the right price axis at the right side of your chart. If you press the left mouse bottom on the right price axis you can drag the prices and adjust your chart on the vertical price scale. To adjust the horizontal date scale hit the up and down cursor key. After that you should grab the whole chart by clicking in the middle of the chart and holding the left mouse bottom and move it into a place where you can see the relevant information. After finishing these adjustments you can click on the background dragging button again and choose “Disable and Maintain current scale range”. This will leave your settings in place and enable you to use the normal tools again.
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VIX Lines
Figure 4: Manuel dragging
Same chart and same timeframe as the chart above but background dragged to the relevant information. You can see silver has recently hit the VIX resistance line and is having a little reversal.
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VIX Lines 3
Learn to “read” the VIX-Lines
Learn to read the trading information out of VIX-Lines. 3.1
Major VIX Line
Figure 5: Reading the major VIX-Lines VIX-Lines are based on a very complex algorithm. Their calculation is based on recent price history and their core is a future measure of consolidated implied volatility. The upper VIX-Line (showing overbought situations) is red; the lower VIX-Line (showing oversold situations) is blue. All “trade-with-me” products have the TWM prefix. Some basic features of the VIX-Lines are: When price approaches the VIX-Lines it can be assumed that price reverses or pauses Extreme immediate support is reached when price touches or crosses the lower VIX-Line Extreme immediate resistance is reached when price touches or crosses the upper VIX-Line The above behavior characteristics are present throughout all chart periodicities You can learn to read the VIX-Lines like a native American can read the nature and the forest. Note that it is possible to read a trend from the VIX-Lines and that upper and lower VIX-Line can move in different directions. Figure 5 gives you some hints to read the VIX-Lines. At a.1. you can see both major VIX-Lines in an upward angle. This is a sign for an upward trend. In a.2. you can see the upper VIX-Line flat and the lower VIX-Line increasing. This is a sign that there is no clear trend because in a trend both VIX-Lines (lower and upper VIXLine) have to increase for an uptrend or decrease in a downtrend. Note that VIX-Lines have a very strong predictive character. If the asset is turning around before reaching the major line it is a sign for weakness (see b.1.). Theoretically we would aspect that in 99,9% the asset changes direction for a minimum of 2 bars on the point where it reaches the VIX-Line (see b.2.). If the price of an asset hits the VIX-Line or hits through the VIX-Line it is a sign of power. If the VIX-Line is hit with a huge TrueRange number (or a big candle) it is to assume that it will result in a strong reversal before the trend can go on. If the price has travelled far before reaching the VIX-Line or the level has not been reached for a longer time period it can be assumed that the probability of a reversal is higher.
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VIX Lines 3.2
VIX support and resistance Lines
Figure 6: VIX S/R Lines VIX support and resistance lines are other features of the VIX-Lines package. They provide further information about the future support and resistance areas on the chart.
VIX support lines 1,3,6 and 8 are the dominant lines, VIX support lines 2,4,5 and 7 are the weaker support lines Once a VIX support line has shown to be a dominant line it can be assumed that it will be dominant in the future (see the example of the dominant resistance line changing from VIX resistance line to VIX support line). Trading ranges are frequently formed between supportive VIX lines VIX support lines become resistance once they are broken; resistance lines becomes support lines if broken Breakouts above the first red line (VIX support line 5) or below the first blue line (VIX support line 4) indicate possible beginning trend formations or continuations If the VIX support lines bundle (more than 1 line is at the same place) they get stronger If VIX support lines from different timeframes are close to each other they become more significant. For example if a daily support VIX line can be found on an hourly chart at the price same level it is much stronger.
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VIX Lines 3.3
Trading example
3.4
Times to trade
IMPORTANT: If markets move due to strong fundamental news (like Greece thinking about leaving the EU or the FED increasing interest rates or earthquake in Japan …) the price may move without reversing at the VIXLines. There are markets which are influenced by black swan events on a regular base (for example currently the Euro currency with the EU membership debates) and there are markets with a steady flow without big surprise news. You should prefer times when no big news is on the way. Sometimes it may take some time for the market to digest the news and big fundamental news may have their “dayafter”. My favorite news sources are Forexfactory and Econoday but there are many others, too. I trade commodities also in very volatile times (for example like the silver crash in early May 2011) and found for me, that they tend to follow the major VIX-Lines even on those volatile days. I recommend beginners to be careful on trading futures on volatile days or news days but if you have enough experience it may work well. I have good experience with trading non branded stocks (means not Google, Microsoft, Nestle, etc.) on nondividend days over a couple of days on the hourly and daily chart and I would recommend this for a beginner. You can find such stocks under “Insert – Insert Symbol list”. It is best to trade in the direction of the higher timeframe (for example in the direction of the daily timeframe) and you will have the strongest evidence if an overbought or oversold dot is combined with a bar hitting the major VIX-Line.
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VIX Lines 3.5
Different timeframes
Figure 7: Daily timeframe
This chart shows silver from February to Mai 2011 as on a daily timeframe an example. If an asset is trading above the VIX1 support line (highest dotted red line) you should be aware that the asset might be in a bubble. If you plan to join such a trend it is recommended to wait till the price has come back to the VIX-Lines and a blue oversold dot shows up. You can see the silver futures running along the upper major VIX-Line from mid-February on. The VIX support lines (dotted lines) have predictive character for the daily and lower timeframes. Silver has reached a (temporary) low at the support VIX-Line number 5 (highest dotted blue line). On 9th Mai silver was in an oversold situation on the daily timeframe and looks to have found support at VIX support line 5. If the daily (or higher) timeframe supports a long position you can change to the lower timeframe to find a good entry point for a long position.
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VIX Lines
Figure 8: The 15 min timeframe
Point b. is a good point to enter a long trade at the 15 minutes Silver timeframe. The point b. is a VIXLines buy situation because the higher timeframe indicates a buy, the OBOS shows an oversold situation and the price has hit the lower VIX-Line. The point c. is a VIX-Lines sell situation because the OBOS shows an overbought situation and the price has hit the upper VIX-Line. At the point a. you can see an entry information which is only recommended by one system (the OBOS system). It would result in a loss if traded for some hours. Note that this “wrong� information would be measured as correct in a test because the price goes up for the next two bars in the downtrend.
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VIX Lines 4
Workflow and Radarscreen
As a trader you are a producer of trades. If you produce good (= winning trades) you will earn money, if you produce bad trades (= loosing trades) you lose money. For your production process (the trading) you need good instruments and a workflow which enables you to produce high numbers of good trades. The following chapter should help you to arrange your workflow and to keep overview to produce good trades. 4.1
The workspace
Figure 9: The Workspace with Radarscreen, two Charts and a Matrix window
Tradestation Radarscreen is like a table of charts, showing the important information of each chart in a table. The workspace shows a Radarscreen window, two Chart windows and a Matrix window. All windows are connected through the window link (see 1). At Figure 9 you can see a green “S” window linking button and a blue “I” interval linking button close to 1. The green “S” button changes all the charts which have the same green “S”. The blue “I” button changes the interval on all charts which have the blue “I” active. You should read further in the Tradestation manual if you are not aware of these features. Linking windows with these buttons has the benefit that if you click for example on weekly @ES symbol in the first row Chart1 will change to @ES weekly while Chart2 changes to @ES symbol but stays on the hourly timeframe (because it has no blue “I”). If you click on the second @ES symbol Chart1 will change to a daily timeframe and so on. The benefit of having the same symbol with different timeframes is that you can change the timeframe by clicking. At the Radarscreen window: The two basic elements of VIX-Line (OBOS and VIX-Lines) are available in Radarscreen, too. The OBOS column shows how many bars ago an oversold or overbought situation has happened. An old signal is displayed for a maximum of 3 historical bars (you do not need information about old oversold or overbought situations).
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VIX Lines The VIX-Line column is showing how far the last price is away from the VIX-Line. The number is not correlated with the price, it a standardized number to make the different assets comparable to each other. If the word “Upperline” is the first expression you can assume that the VIX Upperline is closer to the last price than the VIX Lowerline. The smaller the number the closer the last price is at the VIXLine, if the number is negative the last price has left the lines (and should return into the lines soon). When I put the symbols in the Radarscreen I always put a custom tradeable contract at the last row (see 2) and continuous contracts in the other rows. It provides the benefit that if you click on the tradeable contract (which is always the lowest timeframe because I always trade on the lowest timeframe) everything changes to tradeable contracts and you can put orders in the system. The benefit of having the same symbol with different timeframes in one Radarscreen window (see 3) is, that it provides a very fast overview about different timeframes in only one window. For example in this window you can see that some of the lower 15 min timeframes are oversold (see OBOS column) and the lower timeframes from 15 min over 60 min to daily are near the lower VIX-Line (see VIX-Line column) and the higher weekly timeframe is still at the Upperline (upper VIX-Line). From this information it is possible to draw the conclusion that we are in a long term uptrend on a weekly timeframe but have a pullback on the smaller timeframes (15 min to daily). Next to overview all the timeframes you are able to overview all indices. For example the FESX (EUROSTOXX) is at the Lowerline with all timeframes. As todays markets are highly correlated it might give a hint if some indices have turned into a downtrend while others are still up. 4.2
Dealing with huge number of symbols
If you trade Futures you have to handle a relative small number of symbols, if you trade equities you may have to handle very huge amount of symbols. As Tradestation user you have the benefit that Tradestation has automated pre scanned lists which contain all the equities you want to analyze. The Tradestation Radarscreen is a superior technic and better than the Tradestation scanner and the first choice for analyzing.
Figure 10: Insert pre scanned symbol list
As pre scanned lists I recommend the “all 5 day Avg Vol & > 5$” list because it combines high volume with a tradeable price. Click in the Radarscreen window (see1), click on insert (see2), choose “all 5 day Avg Vol & > 5$” and press ok and the stocks will be inserted into Radarscreen. If you use the readymade list you have the benefit that you always have stocks with enough volume and a tradeable price. I only trade stocks between 5 and 80 US $ in multiples of 100. I never invest too much in one stock.
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VIX Lines
Figure 11: After having inserted the stock list
After you have inserted the list your Radarscreen should look like this. All inserted symbols have the same timeframe. Scroll down to the first empty cell and repeat the process, insert again the same list.
Figure 12: Insert the same again
Now you have two times the same symbols in one list. Delete the blue label row.
Figure 13: Change symbol timeframe
Now mark all symbols from the second insertion and change the timeframe to a timeframe separate from the first (for example if the first is daily you should change the second to 60 min). Now you should have all symbols in the list double, one with daily and one with hourly time. Now sort the symbols by symbol name.
Figure 14: All symbols have two timeframes now
After sorting the symbols by name we can see that Masco (MAS) is overbought on daily and hourly timeframe and has shot above the upper VIX-Line. It can be a great opportunity for a Short entry, but before we enter the trade we do a fast check for news via the Tradestation news center (located on - 13 -
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VIX Lines the tools bar under “news”) and in the market depth (located on the tools bar under “market depth”) to ensure that there are no big buys in the order book. This can be done with one mouse click and takes only some seconds but provide additional security. In our example there is not big new, only a recommendation from an analyst company and we can do the short trade. Note that Radarscreen cannot run on tick-by-tick bar with VIX-Lines because even strong personal computers are not able to calculate it tick-by-tick and the indicators will show wrong results. You should not change the settings to tick-by-tick, if you have issues you should reload the template. I experimented with the new Tradestation9 features to show different timeframes but I found the solution above as the best and most reliable way to accomplish the task of finding the right stock. 4.3 4.3.1
Technical details Bars back and CPU power
VIX-Lines are based on a complex algorithm. For this reason VIX-Lines need some CPU power to be calculated. On the programming, everything was done to reduce CPU usage but you can help to reduce CPU usage, either. You can reduce the need of CPU power by reducing the “bars back” in the Tradestation chart. Try to use the smallest possible number of bars back at “Format – Symbol – Bars Back”. It can be recommended to go 700 bars back because a modern computer should be able to handle these calculations in a couple of seconds. If you use excessive amount of bars back data (for example 10 years) it may take some minutes to calculate.
4.3.2
Errors
If something is not working correctly have a look at your print output (at view – easylanguage output). VIX-Lines will provide info on typical errors and mistakes via print output.
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VIX Lines 5
Work in progress – please provide your input
My dream is to get the best possible trading system. For this reason I will develop VIX Lines further. This will include:
A tool to identify the big trend and the reversal and show the information in a trend indicator ribbon Better ways to identify the slope of the VIX Lines and read market information out of the slope Automation Features like volatility Entries and Exits which are combined with the VIX Lines Adjustable second timeframe in Radarscreen and the Chart
Please help me to improve VIX-Lines and provide your input to:
What works especially good and what not What features or functions are missing What should be improved or changed
Please write me an email with your feedback to mirko@trade-with-me.net
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VIX Lines 6
Me, the author
In the first instance I develop indicators and strategies for my own trading activities. As trading is a team sport and there is no negative implication to give these tools to others. I give others the opportunity to trade with my indicators – this is the reason why I call it “trade-with-me”.
Dr. Mirko C. Ulbrich About me: Has worked for > 10 years for P&G and V&B Trades stocks since 1999 with focus on commodities since 2008 Lives in Saarlouis, a little town at the German/French/Luxembourg border Fan of Tradestation Develops trading algorithms as hobby Has studied economics and business (German “Diplom”, equivalent to MBA) Has written his PH.D. thesis about statistical methods (German “Doktorarbeit”)
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VIX Lines
7
Disclaimer:
VIX-Lines are a Tradestation add-on. VIX-Lines are not connected to Tradestation, Tradestation is a separate company. All the examples are for illustration only and do not contain any trading advice. For trading advices ask your registered CTA or BAFIN certified banking consultant. All pictures and screenshots are made with Tradestation. TRADING INVOLVES SUBSTANTIAL RISK AND IS NOT SUITABLE FOR ALL INVESTORS. PEOPLE CAN AND DO LOSE MONEY. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. ALL EXAMPLES IN THIS BOOKLET ARE HYPOTHETICAL AND NOT A RECOMMENDATION TO TRADE A SPECIFIC ASSET.
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