$VIX Makes a New 197 Day Low. What Happens Next?

There was a fair amount of news today about $VIX closing beneath 16. The last time it closed at this level was July 8th, 2011. Today also marked a new 197 day low for $VIX. Let’s look at what happens next after $VIX makes a new X day low.

The Rules:

Buy SPY at the close if

• $VIX makes new X day low

Sell the position at the close Y days later. No commissions or slippage included. All SPY history used.

The Results:

As new X day $VIX lows increase, so does the depth of the pullback that seems to inevitably occur over the next week.

Similarly, the greater the new X day low, the greater performance is punished going forward. The sweet spot seems to reside somewhere between a new 50 and 100 day low.

Today’s current value, a 197 day new $VIX low, yields the poorest performance.

The white Buy-n-Hold line was generated by separating SPY performance into 50 day segments and then averaging those segments.

Thoughts and Caveats:

All runs had enough samples for results to be generalized.

I’m not sure whether I want to make any predictions from these results. Volatility could easily continue to fall, or even flatline. My gut says it won’t, and that a market pullback of a week or so will result in $VIX rising from its ashes.

In this recent post, I noted it had been 40 days without a pullback greater than 1%. 6 days after the post, SPY saw a one-day fall of -1.5%. If we bought at the close of the pullback day, what would results look like going forward?

The Rules:

Buy SPY at the close if

• it has been more than 40 days since a one-day fall of more than -0.99%
• and it falls more than -0.99%

No commission or slippage included. All SPY history used.

The Results:

Thoughts and Caveats:

For the purposes of comparing results, the red line shows the average SPY performance of buying it at the close after any one-day pullback greater than -1%.

Results are still solidly bullish.

There were only 13 occurrences of this setup. The next most recent one was January 28th, 2011. Shortly after that setup, the market underwent almost 11 months of consolidation and volatility.

Bottom line: The market’s ability to go more than 40 days without a pullback greater than 1% shows an incredible amount of momentum. In the past, the momentum did not appear to be suddenly stopped after a one-day pullback greater than 1%.

Starting to get some distance between the ROC252 and ROC5.

The system is down -0.5% for 2012. Not great, but remember this was started as a long-term trend following method. Watching it handle lots of whip-sawing and volatility in real-time has been interesting…

Still, if the ROC252 can manage to stay above the ROC5 during the next pullback, we may be seeing the emergence of a long-term trend signal on the long side. I’m not saying the signal will be correct. But it’s the first one that’s emerged since November 2011.

I’m tracking two systems which I refer to as Version 1 and Version 2. Version 1 is the older Fidelity funds rotational system that I wrote about over 2 years ago. Version 2 is the more recent and updated version.

Starting February 1, I began trading a Fidelity 401K account using version 1. I want to watch version 2 and give it some time to develop an out-of-sample record before committing capital to it.

Below are the results of both versions since February 1.

From the close of February 1st to the close of March 2nd, SPY gained 3.65%. Both versions underperformed.

The good news is that the price I’m getting through Fidelity is the same price Yahoo is publishing in its historical data. There have been no issues with trade executions. The system has been very easy to trade up to this point. The only daily maintenance required is to run the ranking of the funds after the close. There are two funds in version 1 that have exceeded the 30 day minimum hold. As soon as they drop out of the top three, they must be replaced. Version 2 does not currently require any daily maintenance as all three funds are new purchases and must be held for 30 days.

I submit to you the above graph showing the percentage of stocks trading above their 20, 50, and 200 day moving averages.

These percentages have been slowly rolling over for the past month or so while SPY continues to climb.

The indices will not continue to climb forever while their constituent stocks are rolling over.

The correction has already begun. Look for it to show up in the indices soon.

Yesterday, 3.1.12, was exactly 30 days since purchase of the three top-ranked Fidelity Sector funds. That means that a re-ranking of the funds was completed after yesterday’s close so that any rotations can be made at today’s close.

The top three positions last month for version1 of the system were FSHOX (Construction and Housing), FBIOX (Biotechnology), FSRFX (Transportation). FSHOX and FBIOX are still in the top-three. FSRFX has dropped out of the top three and has been replaced with FSHCX (Medical Delivery). Therefore FSRFX will be sold at today’s close and replaced with FSHCX. FSHOX and FBIOX will be held until they drop out of the top three.

Version 2 of the system has ranked the following funds as the top three: FDLSX (Leisure), FSHOX (Construction and Housing), FBMPX (Multimedia). It will drop FBIOX and FSAIX, keep FSHOX, and add FDLSX and FBMPX.

Eventually I’ll create a chart to help make tracking these easier.

Over this weekend I’ll update the system with the actual trades made at today’s close.