The CBOE Volatility Index (VIX) measures expectations for volatility in the next 30 sessions, with put and call options activity underlying its calculations. While VIX focuses on S&P 500 data, traders and hedgers can also examine the Nasdaq 100 through the CBOE Nasdaq Volatility Index (VXN) and the Dow Jones Industrial Average through CBOE DJIA Volatility Index (VXD). (See also: The Volatility Index: Reading Market Sentiment.)
Moving averages applied to VIX form the basis for a wide variety of buy and sell strategies in broad-based instruments, like the SPDR Trust (SPY), as well as volatility-based futures contracts and exchange traded funds that include:
- CBOE Volatility Index Futures (VX)
- S&P 500 VIX Short-Term Futures ETN (VXX)
- VIX Short-Term Futures ETF (VIXY)
- S&P 500 VIX Mid-Term Futures ETN (VXZ)
However, it’s best to apply technical analysis directly to the index, avoiding futures or funds calculations because pricing in those instruments decays through roll yield and contango, which reflect timing variations between future and spot prices. Smart traders can overcome this deterioration by rolling futures contracts, but funds track continuous charts that make them unsuitable for holding periods lasting longer than a few days.
Traders measure volatility trends with long- and short-term VIX charts, looking for sympathetic equity, options and futures exposure. Rising VIX tends to increase correlation between equity indexes and underlying components, making index funds more attractive than individual securities. Falling VIX reverses this equation, supporting a stockpicker’s market in which individual securities offer better trading opportunities than do index funds.
Intraday VIX Moving Averages
The intraday VIX chart provides an important internal gauge of volatility and risk sentiment over short time frames. The feedback can be used as a reliable but supplementary entry trigger for trading baskets that favor risk assumption (buying growth instruments and selling defensive instruments) or risk aversion (buying defensive instruments and selling growth instruments).
A 15-minute time frame works well for this purpose, focusing on reversals that mark sentiment shifts during the trading day. However, intraday VIX patterns can look ragged, making it hard to find reliable signals. Placing a 10-bar SMA over price action smoothens these turns, increasing signal while reducing noise. Along with NYSE TICK and advance: decline data, the trio of indicators can read price and sentiment swings with surprising accuracy.
In this example, a 10-bar SMA over 15-minute VIX shows five key turns in six sessions while the underlying indicator flips back and forth at least a dozen times. When trending higher or lower, the moving average points to significant market action, as it did between Aug. 11 and 13. The S&P 500 index sold off more than 50 points (A) during that period, before turning higher in an intraday reversal (B) that featured a 34-point intraday recovery.
This short-term analysis works less reliability in quieter sessions on Aug. 14 and 17, with the moving average grinding out a series of short-term highs and lows. It captures an early sell-off (C), and an afternoon bounce (D) on the 14th but fails to turn lower until mid-afternoon on the 17th (F), hours after the market rallies out of a weak open (E). The VIX closes that session in the green despite healthy S&P 500 gains, signaling a minor bearish divergence.
Daily and Weekly VIX Moving Averages
Moving averages applied to daily and weekly VIX measure long-term shifts in market sentiment, as well as shock events that trigger vertical spikes out of basing patterns. These sudden increases in fear levels, whether in in reaction to destabilizing economic data or natural disasters like the 2011 Japanese tsunami, have an immediate negative impact on investor psychology, triggering emotional selling pressure that can cause a significant drop in world markets.
The 50- and 200-day EMA work well together on the daily VIX Chart. Moving average crosses can mark significant psychological shifts, with the 50-day crossing below the 200-day signaling improved sentiment, while the 50-day crossing above the 200-day pointing to deterioration. For example, a 50-day above 200-day crossover (A) in October 2014 precedes a 145-point S&P 500 sell-off. Crosses routinely occur as a result of vertical spikes and subsequent recoveries, allowing the observant technician to time the shift between rising fear and a return to complacency.
A 20-day Bollinger Band set to two standard deviations adds considerable information to the daily VIX analysis, with vertical spikes pushing 100% outside the top band signaling a pause or reversal, as they did in October (B) and December (C). Subsequent spikes run into hidden resistance at the horizontal top band, triggering three reversals in January and February (D, E, F).
The weekly VIX chart tracks long-term shifts in sentiment, including the transition between bull and bear markets. The relationship between VIX and the 200-week EMA is especially useful in this regard, as you can see when looking at the chart between 2003 and 2011. The 200-day EMA became resistance when price fell through the moving average in 2003, signaling a new bull market, and mounted it successfully in the summer of 2007, just two months before the cyclical top.
This analytical process continued to work well in the next four years, with price settling below the 200-day EMA in the middle of 2009, just a few months after the bear market bottom. It pierced that level during the May 2010 flash crash but worked its way lower by the summer, indicating that destabilizing event had failed to trigger a new bear market. (See also: Volatility Index Uncovers Market Bottoms.)
The Bottom Line
Moving averages applied to CBOE S&P Volatility Index (VIX) smooth out the natural choppiness of the indicator, letting short-term traders and long-term market timers access highly reliable sentiment and volatility data.