FVE Indicators Creeping Up

 Volatility has been fairly flat for the week.  While VIX remains well below 20, VIX Futures have been reluctant to fall below the 20 level.  FVE indicators, however, are now slowly rising and since VIX & VIX Futures are at "fair value" to FVE2 & FVEF indicators, the model has signaled to exit short positions.




For others that are on a similar path...

As for my continued efforts to secure a meaningful opportunity to access capital to trade my FVE model, I have faced much frustration thus far.  More and more people I meet are very impressed with my volatility model, but one prop trading firm only wants day traders with 3 year record.  Another prop trading firm thought my strategies were too volatile for their taste (Of course any strategy with 100%+ return potential would also have higher drawdowns than say a strategy with 20% return potential).  Still other prop trading firms are still only looking to hire quants.  Does a mathematics or programming expertise really trump keen market insight and experience as a trader or someone that already has a unique model that can be implemented today to generate profits?

Still, the live account is up over 45% since 11/16/2011, and I figure it's only a matter of time before my model draws greater interest.  I have also found that rewriting my report has helped explain my model and trading strategies in a clear and easy to understand manner.

Another area where I believe my Fair Volatility Estimate (FVE) model can add value is in quantitative portfolio allocation.  Alpha = Due Diligence + Time +VOLATILITY.  I have begun to send resumes to High Net Worth Investment Advisory firms that recommend portfolio structured around alternative investments.  I believe my FVE model can help to reduce risk when risk of loss is greatest (volatility spikes and correlations converge to 1).

FVE Indicators Snapshot & Performance Update

VIX & VIX Futures are at or near their "fair values" according to my FVE2 & FVEF Models.  Trading signals remain short.  The effectiveness of the original FVE tends to fade at values under 18, although I cannot say to what extent quantitatively.  FVE2 & FVEF were created to alleviate some of FVE's perceived shortcomings.  FVE remains an excellent model to be incorporated in various trading strategies.




Black Box Simulation is real-time, hypothetical results following trading rules preset during backtesting research.

Gray Box is real-time results of actual trades.  Three trading rules are utilized in the Gray Box system.  Discretion is used as to which one to follow, whether trades are to be executed intraday, and whether leverage is used.

Potential for Diverse Trading Strategies with FVE

 FVE indicator can be incorporated into diverse trading strategies. Top left shows the daily equity graph for intraday strategy simulation using FVE buy/sell signals.  Buy/Sell VIX futures on Open & Exit on Close. (50 contracts, 0.025 slippage, $125 commissions).  Annualized return 110% on $500k margin.

If we were to utilize an intraday filter, such as constant volume bar breakout, I am positive the results would be much better.


Bottom left shows the daily equity graph for VIX futures spread strategy.  Based on FVE Buy or Sell signals, one can buy (sell) the near month VIX futures and sell (buy) the next month futures.  I ran the simulation for both the front month / second month spread & the second month / third month spread.

This simulation was conducted from July 1, 2007. (50 contracts spread, 0.025 spread slippage, $100 commissions).  This strategy is more fitting for firm traders rather than individual traders.  A market maker could leg into the spread strategy for positive slippage.

VIX & VIX Futures Significantly Overvalued

VIX futures soared this past Friday.  Near its highs on Friday, VIX futures rose as high as 20% above the value of FVE Futures, which was at the top of its 2-year overvalued range!  Closing price of VIX Futures was still 14.1% overvalued.  Does the options market know something that the underlying market does not?  If investors were that concerned about Greece, you'd think the underlying market would have shown greater volatility and a steeper fall.

Or was Friday a great opportunity to sell VIX futures?  My model says VIX futures really overvalued!

VIX & VIX Futures Diverges From FVE

Last weekend, VIX & VIX futures were in undervalued territory.  With the sharp rise in VIX & VIX futures from 17.95 to 20.0 thus far this week, they have quickly moved to "overvalued".  This does not mean, however, that the long position should be exited just yet.

FVE usually leads or is concurrent with the VIX, thus when the direction of FVE diverges from the VIX, it presents a good trading opportunity to bet against the VIX.  There are instances (20-30%), however, when FVE lags the VIX.  Could this be one of those instances?



Gray box & Black box trading record explained.

Black box hypothetical results are based on one predetermined trading rule using the FVE.  Gray box actual live account results are based on 3 trading rules, one each utilizing the FVE, FVE2, & FVE Futures indicators.

Discretionary judgement is used to determine which of the 3 trading rules are to be followed at any given time.  Furthermore, because execution on the live account is done manually, calling it a graybox system is more accurate.  The live account does not follow an automated system.  It would be interesting to see which method performs better over time.  Regardless, either the graybox or blackbox methods should deliver outstanding performance.

VIX & VIX Futures Now Undervalued

 

   VIX closing value of 17.1 is now in line with Fair Volatility Estimate (FVE)'s value of 17.02.  I believe it's time to look to buy volatility, although an uptrend in FVE has not materialized.  Recently, I have added 2 more variations to my Fair Volatility Estimate Model, the FVE2 & FVE Futures.  FVE2 is used to look at VIX value and FVE Futures (FVEF) is used to look at VIX front month futures value.  VIX is below FVE2 and VIX Futures is below FVEF.  Based on my models, VIX & VIX Futures are now below "fair value", whereas since end-of September 2011, they were mostly overvalued.

DISCLOSURE on LIVE ACCOUNT PERFORMANCE.

    Unfortunately, trades were made in the live account I was utilizing to build my trading record by my partner without my knowledge this past week.  It was an honest mistake--breakdown in communication, but I feel I have to start over.  For my diary records, my system exited the short position on 1/30/12, so I would have missed the continued plunge in volatility this past week.  From 11/16/2011 to 1/30/2012, the account returned 17.9%.

SOME OF MY COMMENTS ON DISCUSSION GROUPS

Relating to simulation backtests on FVE...

My backtests were carried out with hard rules using the Fair Volatility Estimate (FVE). For ex, 1) Buy VIX when FVE>FVE X days ago AND Previous VIX< Previous FVE and VIX>Previous VIX, 2)Exit when VIX >y% above FVE on daily close, 3) Reverse rules for Short and Exit Short. I tested for x= 5 to 12, y=0% to 9%. Out of 80 combinations since 10/1/2009, worst had 39.38% annualized return, best had 220.58% annualized performance--using 1/2 the available capital & 0.08 pts slippage. Of course, VIX is not a tradeable instrument, so I took one of the combinations near the middle with 121.62% annualized performance and ran simulation on front month VIX futures. To my surprise, the simulation resulted in 220% annualized returns (the term structure of VIX futures added to the performance). So based on these and other simple backtests, I made the assumption that a trading strategy utilizing the FVE would yield 50-100% annualized returns.

Of course, live trading is very different from simulation. Furthermore, the questions & challenges I am facing will probably be the same ones anyone else walking a similar path would face. 1) Is it better to achieve profits or show integrity of the trading system from the beginning when your credibility is most at question? 2) Am I trying to showcase ME or my system? 3) Can you truly separate the person from the system or should you factor in that human intervention is going to play a part and just record the effects of that? Of course, I had not quite answered these questions for myself, thus the early exits, but I am taking steps to resist (prevent myself from) the urge to intervene.

Example of market changes that would make a profitable system no longer profitable...

I used TradeStation Constant Volume Bars in intraday system to trade Kospi200 index futures back before 2004. The system was pretty profitable until Citadel came into Korea's option market & crushed implied vol, which in turn crushed actual volatility. Smaller movement=small profits if the system is trend or breakout following. Have u considered trading VIX futures with CVB & breakout system? I figure if an underlying moves >40 vol, most intraday breakout systems would show solid profits. Thinking of coming up with my own intraday system trading VIX futures. Also, this is just my thought, not based on data, but I wonder with computerized trading dominating volume, wouldn't volume-based indicators lose some of their effectiveness? Assuming technical indicators are trying to reflect market psychology...? 

Why qualitative analysis is just as, if not more important, than quantitative analysis...

I first learned technical analysis in 1996 and started analyzing the Korean Stock Index. In backtests of MAs, the 3-day SMA consistently outperformed all other MAs, but 4-day MAs were significantly less profitable. I never traded it because I didn't have confidence in the data, but the 3-day SMA "worked" until it stopped working in 1998. Much later on I realized gov't regulation and changes to the "day-trading" rule may have been behind this. Before the change in 1998, a speculator's entire account capital would be tied up for t+2, regardless of whether a stock was bought & sold on the same day.

The 22-day period may have significance for various reasons. There are roughly 22 trading days in a calendar month. Futures and Options positions are unwound every expiration, Fund flows to the market may follow calendar month or payday/expense periods, etc. and yes, if enough investors believe and act upon Fibonacci numbers, then "external" forces may become "internal" forces in the market.

Quantitatively, 22 may be a curve-fit number, whereas qualitatively, one could think of it as a very meaningful number. I hope I didn't just state the obvious. Sorry if I did.

Live Trading Account Performance Update

One of the biggest unknown factors with any trading system is human judgement and intervention.  Where I thought I was being prudent to take profits earlier on 2 trades, I ended up instead just reducing the performance of my system by greater than 5%.  Nevertheless, these are the benefits of trading a strategy on a live account.  There are so many other factors that are outside of a controlled simulation.

Furthermore, the loss on the second trade of 11.3% was quite significant but not entirely alarming.  Performance results from simulation from September to November of 2011 was uncharacteristically high and volatile.  Also, the average days a trade lasted was 8 during simulation, but so far, it has been 18 days.