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Capital Allocation based on the Expected Market Volatility (VIX)
The expected US Market volatility for the next 30 days is measured by the VIX or the Chicago Board Options Exchange Market Volatility Index.
The VIX measures the implied volatility of the S&P 500 index options. It is a very popular index introduced by Robert Whaley in 1993. The index is often referred to as the fear gauge or the fear index.
The VIX is used in this money management script to detect whether the expected market volatility is increasing or decreasing. The money management strategy then changes the portfolio maximum exposure or the percentage of capital to invest depending on that.
Capital allocation or the percentage of capital to allocate to the portfolio is equal to X% if the VIX is higher than its N-bar simple moving average (The remainder is kept in cash). Otherwise, it is set to 100% (Portfolio is fully invested in case the expected volatility of the S&P 500 is decreasing - VIX is lower than its SMA).
The X and N variables, which correspond to the percentage of capital to allocate to the trading strategy and to the VIX moving average period, can be updated and optimized in the money management variables panel. This panel is visible when you select a trading system in the Simulator form.
This strategy can be applied to any system. It can reduce your portfolio volatility, maximum drawdown and may also increase your strategy annual return and Sharpe ratio.
To apply it, update your trading system, select Money Management then click on "Add an existing Money Management Script". You have to download this trading item before doing that.
Note that after each change in the portfolio (change in capital allocation) the VIX rule is not checked for the next five bars. This is to prevent frequent changes (In case VIX crosses its moving average several times within a very short period).
