Volatility Trading Strategy from Larry Connors

 Larry Connors is the KING of mean reversion trading strategies, and this article reinforces that royal standing.  :)   In a nutshell, volatility – as a phenomenon – can swing higher and lower in the short term, but it strongly gravitates toward its own comfort zone.  That zone, the average (or mean), can move higher or lower over longer periods of time, but in the short to medium term time frame, it is where the volatility will hover.   This trading strategy is a good way of taking advantage of this reality.
 
One note though, and I’m a bit surprised that Mr. Connors didn’t make this explicit: this is a one direction strategy.  In the setup he discusses using RSI(2) over 90 as the trigger, and often an experienced trader will understand that an inverse strategy would work at the other end of the RSI spectrum.  But not in this case.  Primarily, this is because the VXX (the ETF being traded here) is continually falling (check out a year chart to see what I mean), so trying the same thing from the RSI(2) < 10 side of things is NOT indicated. 
 
With that caveat in mind, please read and enjoy!
 


 

A Low Volatility Strategy for Trading High Volatility

By Larry Connors | TradingMarkets.com | July 13, 2012 09:06 AM
 
 

 

We’re going to show you a volatility trading model for VXX which has correctly predicted the price of VXX 97.3% of the time since VXX started trading in 2009. The test results are up through the end of May 2012.Trading volatility, especially VXX, has become a big game among professional traders. You only have to look at the continuously rising average volume in VXX, combined with the many new volatility products that have been coming to the market over the past year, to know that volatility is beginning to join the ranks of other asset groups such as stocks, ETFs, options, forex, and futures.Much has been written about how to trade VXX; unfortunately the majority of the early volatility trading strategies were incorrect. Too many people were comparing VXX to VIX and had considered them the same instrument. They’re not.VIX is an index that settles on a value each day based on the underlying vehicles in the index. VXX is the expected future value of where traders believe volatility will be in the near-term future. One is today’s value (VIX). The other is the marketplaces prediction of where these prices will be in the future (VXX).

There are certain characteristics of volatility which are inherent (and sometimes in conflict with each other). The academic world has shown decades ago that volatility is mean reverting. When volatility gets too far away from its average price over a period of time, it tends to reverse back to its average . . . .  read the remainder of this excellent article here


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