The headlines the last couple of weeks have focused on stock market volatility. The Dow Jones Industrial Average (DJIA) had two days last week that were down by more than 1000 points.
The CBOE Volatility Index (VIX) spiked, causing two volatility-based tickers – XIV and SVXY – to lose more than 95% of their value overnight.
The headline-grabbing VIX index is a measure of the 30-day volatility of the options on the S&P 500. The VIX index is a derivative of a derivative. That makes XIV and SVXY derivatives of derivatives of derivatives! It’s really difficult for individual investors to understand the underlying risk in these until something blows up.
With TradeStops, our measurement of risk is much easier to understand. We call this the Volatility Quotient (VQ). The VQ is the Heart of the TradeStops System.
For our many new members, the VQ is the basis for everything that happens within TradeStops. The VQ tells us what the normal volatility is for each stock, ETF, and mutual fund over a 12-36 month basis.
This is an important concept. The VQ looks at each stock. It is not a measure of beta. The beta of a stock is a measurement of a stock’s volatility in relation to another stock or index. The TradeStops VQ stands on its own.
We can see the VQ on the “Stock Analyzer” page under the “Research” tab at the top of the TradeStops site.
After we enter a ticker into the Stock Analyzer, in this case we’re entering Nvidia (NVDA), you can see its VQ underneath the SSI status.
NVDA has a VQ of 29.15%. That means the normal volatility in the stock over a 1-3 year timeframe is 29.15%. That’s how much the stock could move in its normal course of trading over a long period of time. Said another way, that’s how much noise is in the stock.
Within TradeStops, the following VQs are our designations for understanding the overall risk of a stock or fund.
- 5% – 15% = Low Risk
- 15% – 30% = Medium Risk
- 30% – 50% = High Risk
- Higher than 50% = Sky High Risk
Each weekend, the VQ of each stock and fund is recalculated. Since we’re using 156 weeks of closing stock prices, it’s very unlikely that the VQ will move more than a few basis points in either direction.
The VQ cannot be lower than 5%. Many bond funds have had a VQ of 5% in the past few years because interest rates have been so low. Now, we could see the volatility of these funds move higher as interest rates move higher. Also, the VQ cannot be greater than 95%.
The SSI signals use the VQ to determine the health of each stock. NVDA is in a healthy state as it’s in the SSI Green Zone. NVDA triggered a SSI Entry signal back in February 2016 and has been climbing higher for 2 years.
The S&P 500 is in a different state. After almost two years of being in a solid uptrend, the S&P 500 ETF (SPY) hit its Stock State Indicator (SSI) Stop signal this past Thursday.
We’ll discuss more about the VQ and its correlation to the SSI signals in our upcoming educational presentation on February 21st at 1PM Eastern. To register for the webinar, click here.
Research and Education Specialist, TradeStops