Interestingly, if we bought SPX when the five-day moving of VIX was less than 15, the next five days in SPX averaged a loss of -.04%. That would have resulted in a cumulative loss of -3.42% during a period in which the market rose by almost 47%!
Conversely, if we bought SPX when the five-day moving average of VIX was greater than 15, the next five days in SPX averaged a gain of +.52%. That would have resulted in a cumulative gain of nearly 41%, versus the buy-and-hold of 47%. In other words, the vast majority of the market's gains have occurred during periods of elevated short-term volatility.
My point here is not to suggest a trading system, though it's not difficult to conceptualize one from the idea of relative volatility spikes. Rather, the point is that comfortable markets--those with modest volatility--have yielded negative returns. Uncomfortable markets have yielded the bulk of market returns.
A trader's returns have been directly proportional to his or her ratio of courage to fear. Buying ugly markets has made superior returns; stopping out of long positions on ugliness has led to negative timing alpha. Buying stocks when fear is gone and markets are orderly has not paid off.
If there's a formula for trading success, prudent courage is not a bad start. If there's a formula for trading failure, acting on fear--fear of missing out, fear of losses--is also not a bad start. It's amazing how ramping up trading risk/size and trading frequency can turn prudently courageous traders into fearful ones. If there's a formula for risk-taking, trading the largest size that enables you to stay prudently courageous during times of ugliness is a good starting point.
Further Reading: Why Success Lies on the Other Side of Fear
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