March 1, 2022

By:  Jerry Nix | Freewavemaker, LLC

In this article I am going to attempt to show you that you can make money, good money, off other peoples FEAR and GREED.  In my opinion these are really the only two things that drive the stock markets up and down.  If people are fearful of the economy, they tend to hold on to money and not invest or spend much of it.  If they are greedy, on the other hand, they have no problem with spending or investing money.  During period of greed (high confidence of investors and consumers) the market tends to increase in value and during periods of fear (low confidence of investors and consumers) the market tends to decline in value.

As consumers and investors in America (and other parts of the world, generally) we tend to be high on the confidence scale more than low – therefore the markets tend to advance in value about 65% to 70% of the time.  But there are those times when the market is in free fall and we lose money (especially if we close out investments when they have gone below the amount we invested).

So how can you tell if there is fear or greed in the markets at the time it is happening – or as close to it as possible?

ANSWER:  Keep and eye on the VIX Index.

Exactly what is the VIX Index?

According to Investopedia … The CBOE Volatility Index (VIX) is a real-time index that represents the market’s expectations for the relative strength of near-term price changes of the S&P 500 index (SPX). Because it is derived from the prices of SPX index options with near-term expiration dates, it generates a 30-day forward projection of volatility. Volatility, or how fast prices change, is often seen as a way to gauge market sentiment, and in particular the degree of fear among market participants.  It is an important index in the world of trading and investment because it provides a quantifiable measure of market risk and investors’ sentiments.  https://www.investopedia.com/terms/v/vix.asp

The VIX vs. the SPX

With that being said, let’s take a look at the VIX as compared to the SPX (S&P 500 Stock Index) between March 22, 2021 and February 28, 2022.  You will find out later why I chose March 22 as a starting date on this almost one-year lookback.

Performance Chart

The white line represents the S&P 500 Index while the red line represents the VIX.  Along the right side of the graph is a scale from 20 to 60 and this represents the rate of growth both of these indices have shown since starting at 0% on March 22, 2021.

• The SPX is up 10.99% (close enough to call it 11%), while
• The VIX is up 59.69% (close enough to call it 60%).

You will notice, however, the volatility of the VIX (the uptrend and the down trend) is a whole lot greater than the volatility of the S&P 500 (or SPX).  This should tell you something about “Human Emotions.”

Now, while it is true that you cannot buy shares of the VIX or the SPX … you can purchase options on both indices … and you can purchase ETFs or ETNs (Exchange Traded Funds or Exchange Traded Notes) on both.

The VIX and the VIX RSI at a glance from 03/01/2021 – 02/28/2022:

The next chart is the actual VIX index from the first of March last year through the end of February this year (a full year lookback).

It also includes the RSI (or Relative Strength Index).  If you’ve been reading my posts, you know that the RSI is a technical indicator that let’s technical traders (Swing Traders) know if a stock is over-bought or over-sold.  In previous blogs I’ve stated that if the RSI is below 30 the stock is likely oversold and if it above 70 the stock is likely overbought.

Let’s look at this graph, thanks to VectorVest Graphing Software.

VIX Price vs. VIX RSI

Here you notice two graphs.  The top one (green) is the VIX Price Graph from 03/01/2021 through yesterday’s close on 02/28/2022.  The price closed at $23.35 on 03/01/2021 and grew to $30.15 by the close of 02/28/2022.  That’s an increase of about $6.80 or 29.12%.  Not bad, but not great and very volatile.

Looking at the lower part of the graph we see that over the one-year period the VIX RSI crossed 70 many times but only hit 30 one time and never went below 30.  Thus, had this been a common stock it would have been overbought 17 times and only oversold possibly 1 time.

Since this is the case, for this investment program I would say let’s assume that 40 or less is an oversold position and 70 or above is an overbought position.

Buy when oversold and Sell when overbought:

In putting together the investment plan I am referring to in this blog I decided that I would invest money in one or more of the VIX ETFs that are available (and I am not showing them all below) when the RSI of the VIX index (not the RSI of the VIX ETF I’m using) first fell below 40 and sell when the RSI of the VIX index goes above 70 initially.  Then when it falls below 40, I will buy again and sell it again when it crosses the 70 threshold. 

To be able to track this I have put in horizontal orange lines at 30, 40, 50, 60 and 70.  I have also added vertical lines for the dates that I would buy (Blue line) and lines for the date that I would sell the particular ETF (Yellow line).  You can see these on the updated graphs below:

VIX Price vs. VIX RSI with Buy and Sell Lines

Now you may notice that there is no line for 02/28/2022.  The reason for this is because the RSI has not hit 70 as of that date.  However, in the tables that I will show you for 5 different ETFs I will assume that the fund was sold on 02/28/2022 so that we can get a closing value.

Another thing you have to keep in mind … for the sake of simplicity and fairness … I have assumed that the funds were bought and sold in the closing minute of the market.  Naturally with ETFs, which are traded like a stock, you could buy and sell anytime of the day while the market is open … though you may not know what the RSI closed at since this is a daily chart.  Therefore, I decided to use closing prices.

The Five ETFs used in this study:

Let’s take a look at the daily chart for the five ETFs that I have used in this study before getting into the actual numbers.

Proshares VIX Mid-Term Futures ETF (VIXM)

iPath Series B S&P 500 VIX Short-Term Futures ETF (VXX)

Proshares VIX Short-Term Futures ETF (VIXY)

Proshares VIX Ultra Short-Term Futures ETN (UVXY)

After viewing these first four charts your probably thinking … “How does one make money on something that appears to be going lower and lower over time (from upper left corner to lower right corner).  I will share that with you in a moment.

You need to know there is at least one ETF out there that allows for “Selling short” the VIX.  See the final chart below:

Proshares “Short” VIX Short-Term Futures ETF (SVXY)

Now if you would have bought this on the 22^nd of March, 2021 and sold it yesterday, 02/28/2022 – you would have made a little money – but not if you followed the strategy, I am laying out below.

Investment Strategy to make money on Fear and Greed …

This is one way to make money off peoples fear and greed even when the price of the asset is trending down over time.  Go back and look at Figure 3 Price Chart with Buy and Sell Dates.  Here’s the steps to take …

1. Find the VIX fund that more closely matches your risk tolerance
2. Determine an amount of money you can safely afford to lose.  In my example I’ve used $10,000.
3. Find a broker that will allow you to purchase fractional shares – or consider full shares based on the amount of dollars you have to invest (and the shares you buy will probably be valued initially at less than the dollars you have to invest).
4. Buy shares of the fund you desire the first time the RSI for the VIX index (not the fund) falls below 40 (I used 3/22/2022 as my start date).  There are times when it will go below 40 and stay there or even go lower over time – but we do not have a crystal ball and have to draw a line in the sand. This is why I say on the date it first crosses the 40 line.
5. Sell those shares when the RSI of the VIX index (not the fund) first goes above 70.  There are times when it will go above 70 and stay above 70 or even go higher … but remember, we do not have a crystal ball.  This is why I say sell when the VIX index first crosses the 70 line.
6. Be prepared to buy the shares back once you have sold them with the amount of money you have available the next time the RSI goes below 40 and be prepared to sell them the next time the RSI goes above 70.  Wash, Rinse and Repeat until you have met or exceeded your goal.
7. Attempt to make your trades during the last few minutes the market is open.  It only takes a few seconds to buy or sell a position on line.

Let’s see what would have happened on these five funds over the course of almost one year starting on 03/22/2021.

Table 1:  VIXM

Notice I did assume this was closed on 02/28/2022 (in an actual plan we would still be holding it).  But I had to close it to calculate the return for this blog.

It appears it was bought and sold 6 times with only 1 loss period of 43 days.  This gives us a win ratio of 5 out of 6 or about 83.33%.  Most investors are happy with a win ratio of 60% or better.

The average return per holding period was 2.31% and the overall return from start to finish was 14.44%.  Since the average holding period for each buy and sell was 32.67 days the annualized return on investment is estimated at 161.36%.  The annualized return is calculated as overall return divided by average holding period times 365 days per year.  Not bad for an asset that actually went down in value from the opening transaction to the closing transaction about a year later.  However, since there were several days that you were not in the investment you could say the annualized return was 14.44% and be closer to actuality.

Table 2: VXX

Table 3:  VIXY

It appears it was bought and sold 6 times with no loss periods.  This gives us a win ratio of 6 out of 6 or about 100.00%.

The average return per holding period was 10.13% and the overall return from start to finish was 76.08%.  Since the average holding period for each buy and sell was 32.67 days the annualized return on investment is estimated at 850.06%.  The annualized return is calculated as overall return divided by average holding period times 365 days per year.  Not bad for an asset that actually went down in value from the opening transaction to the closing transaction about a year later.  However, since there were several days that you were not in the investment you could say the annualized return was 76.08% and be closer to actuality.

Table 4:  UVXY

Table 5:  SVXY for fun …

If you would have used the RSI as laid out to buy and sell this INVERSE fund (they are short selling the VIX) you would have lost money 6 out of 6 times for a win rate of 0%.  Your average loss per holding period would have been 6.50% and your average loss overall would have been 33.41% of the money you started with.  If you continued this trend over the course of a year’s worth of trades you would have lost all your money and then some.

If you’re going to use an inverse strategy you need to reverse the RSI.  In other words, buy the fund when the RSI of the VIX index first hits 70 and sell the fund when the RSI of the VIX index first hits 40.

Or, you could combine the investment strategy to include two funds – for example – the VIXY and the UVXY.  This is the way that would work:

• When the RSI hits 40 buy the VIXY.
• When the RSI hits 70 Sell the VIXY and buy the SVXY
• When the RSI drops back to 40 sell the SVXY and buy the VIXY
• Continue to do this over and over.  Take a look at the table below:

Table 6:  Buying and Selling the VIXY and SVXY

Rather than just sitting idly buy when the VIX caps 70 waiting for it to drop back to 40 to buy back in … invest in the opposite manner and short the VIX by buying the Short VIX ETF and make money off the fear in the markets.  Based on a comparison of Table 6 and Table 3 you could increase overall returns from 76.08% to 194.02%.  Going from $10,000 to a value of $29,402 in a one-year period means that you have nearly tripled your nest egg.  If you did this every year (grow by almost 3X) it would only take about 5 years and a couple of months to grow $10,000 to a $1,000,000.

Of course, there is no guarantee that you will be able to obtain returns like this each and every year … some years may be great and some may not be so good.  In addition, I would not suggest that anyone put 100% of their portfolio to work in a strategy such as this one.  However, you may want to consider putting as much as 10%, or even less, in such a strategy. 

It would require you to look at the closing value/RSI of the VIX index each and every trading day before the market closes to make a decision as to whether to trade that day or not.  With Smart Phones, as they are today, this may require some action while you are at work, if you’re at work between 3:55 PM and 4:00 PM Eastern Time since the market closes at 4:00 PM Eastern Time.  But trading this strategy – if you stick to the system – should only take a minute or less per day.

In addition, while you should run such a strategy by your financial advisor for their advice, if you have one, do not depend on he/she to do this for you as they simply do not have time to do it with the number of clients they work for at any given time.  If you are fortunate enough to have your own trading robot (a substantial cost) then you can set it up to automatically do these trades for you.  As for me … I’ll do it the old fashion way … by myself (until maybe the fifth year or so).

When setting up any trading strategy, don’t expect to make money right at the start.  If you do, good.  However, don’t abandoned the strategy at the sign of the first loss since no strategy (and I can’t state this enough) is 100% a money maker from start to finish. In the charts and tables, I’ve shown, this may look like the case … but remember I was looking at the past and hindsight is always 20/20!

Good luck with your future investment endeavors and let me know if you were able to get anything that was helpful out of this article.  If you have any questions and would like to reach out to me individually either comment below or send an email to freewavemaker@gmail.com.  When you do remember that I cannot offer advice (that requires a license and I gave that up when I retired three years ago), but I can offer education so that you can make your own decisions.

Thank you for reading this blog,

Jerry Nix | Freewavemaker, LLC