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Capital Allocation based on the Expected Market Volatility (VIX)

by QuantShare, 2357 days ago
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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).


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Type: Advanced Money Management

Object ID: 908


Country:
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Market: Stock Market

Style:
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Trading financial instruments, including foreign exchange on margin, carries a high level of risk and is not suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in financial instruments or foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with trading and seek advice from an independent financial advisor if you have any doubts.