How to trade volatility ETFs during the day

Volatility exchange-traded funds (ETF) and exchange-traded notes (ETN) can sometimes provide interesting day trading opportunities, but at other times, volatility ETFs should exist separately. Volatility ETFs usually move in the opposite direction of major stock market indexes (such as the S&P 500 Index or the Dow Jones Industrial Average).

For example, when the S&P 500 index rises, volatility ETFs and ETNs (such as iPath S&P 500 VIX short-term futures ETN (VXX)) usually fall. On the other hand, when the S&P 500 index falls, volatility ETFs and ETNs usually rise.

Key points

  • Intraday trading volatility exchange-traded funds (ETFs) can sometimes be attractive, but at other times, volatility ETFs should exist on their own.
  • An ETF is an exchange-traded fund that holds related assets of the fund.
  • ETN is a kind of bills traded on exchanges. It does not hold any assets and is structured as debt securities.
  • Volatility ETNs, such as VXX, usually “lead” the S&P 500 index; when this happens, the signal lets you know whether to go long or short.
  • When the Standard & Poor’s 500 Index falls, VXX usually has explosive volatility, and the volatility of VXX usually far exceeds the volatility of the Standard & Poor’s 500 index.

ETF and ETN

Usually called a volatility ETF, there are also volatility exchange-traded notes (ETN). An ETF is a fund that trades on the stock exchange and holds the relevant assets of the fund. ETN is an exchange-traded bill that is also traded on exchanges, but it is structured as debt securities and does not hold any assets.

ETN does not have ETF tracking errors that may be prone to, because ETN only tracks one index. On the other hand, ETFs invest in assets that track the index, and the value of these assets may deviate from the index itself. When there is a divergence, it may cause a performance difference between the performance of the ETF and the index that it should represent.

Nevertheless, both ETFs and ETNs can accept day trading fluctuations, as long as the ETF or ETN being traded has a lot of liquidity, which is measured by the trading volume or the number of stocks traded every day.

Choose volatility ETF/ETN

There are a variety of volatility exchange-traded funds to choose from, including inverse volatility ETFs. Inverse volatility ETFs usually follow the same trend as major stock market indexes (opposite/reverse to traditional volatility ETFs). When trading on the same day, a simple high-volume ETF/ETN is usually the best choice. iPath S&P 500 VIX Short-term Futures ETN (VXX) is the largest and most liquid in the volatility ETF/ETN field.

13.81%

iPath S&P 500 VIX short-term futures ETN year-to-date total daily return (as of December 23, 2020).

Best day trading volatility ETF/ETN

When the Standard & Poor’s 500 Index falls, VXX usually has an explosive trend. The volatility of the VXX usually far exceeds the volatility of the S&P 500 index. For example, a 5% drop in the S&P 500 could cause VXX to rise 15%. Therefore, trading VXX offers more profit potential than simply shorting the S&P 500 SPDR ETF (SPY). Since VXX has a tendency to “overshoot” when the S&P 500 index falls, when the S&P 500 index rises again, VXX usually sells in a dramatic way.

Day traders have two ways to profit:

  • Buy VXX when the S&P 500 index is falling.
  • Short VXX after the price surge, once the S&P 500 index starts to rise again, and VXX is falling.

Depending on the size of the S&P 500 index trend, VXX’s favorable trading conditions can last for several days or as long as several months. The chart below shows the short-term decline and reversal of the S&P 500 index, and the corresponding rise and sell-off of VXX.

The chart confirms that VXX has an overshooting trend; based on the S&P 500 index fell 11.84%, ETN rose 105%. Then when the S&P 500 rebounded 10% from the low, it fell 31.6%. This is when the day trader wants to trade VXX.

When the S&P 500 is in a quiet upward trend and there is little downward movement, VXX will slowly fall. During these periods, it is not suitable for day trading. During and after the S&P 500 fell by a few percentage points or more, huge opportunities emerged.

Intraday trading volatility ETF

Volatility ETFs or ETNs, such as VXX, usually “lead” the S&P 500 index. When this happens, it will let you know which side (long or short) you want to trade. For example, the chart below provides several clues that the S&P 500 index will go higher.

VXX (top chart) weakened in the morning, even though the S&P 500 index (bottom chart) made lower lows, it was generally lower. Then, VXX just passed its main support level at 12 noon, indicating that the S&P 500 may eventually break through its resistance level. It’s done in about 30 minutes.

VXX will not always Leading the S&P 500. Sometimes the S&P 500 will lead, which can also provide us with clues for intraday trading of VXX. When the Standard & Poor’s 500 Index falls sharply (and/or subsequently rebounds), the biggest intraday opportunity appears in VXX. In this case, the following entry and stop loss can be used to profit from volatile ETN.

The diagram below provides an example. At 10:43 AM, the S&P 500 Index (bottom chart) had just made a lower low and then started to rebound. At the same time, VXX (top chart) is well below its high and is forming a lateral channel (highlighted by the rectangle on the chart). The S&P 500 index continued to rise. Day traders should piece together now that VXX is weak (lower lows), and if the S&P 500 index rises, then VXX may soon start to fall.

Wait for the transaction to trigger. This is an event that actually tells you that the price has started to fall. In this case, VXX is moving in a channel above 33.38 USD or a small consolidation. If the price falls below $33.38, the channel is broken and based on other evidence, VXX short trades can be made.

Placing a stop loss order at $0.02 above the most recent high (which occurred before the entry) makes sense to protect short positions. If you go long, the trader should place a stop loss order at a position lower than the most recent low of $0.02 before entering the market.

If you notice that the overall trend of the market is not good for you, then exit the transaction. If you go short, a higher swing low or higher swing high indicates a potential trend change. If you go long, a lower swing low or lower swing high indicates a potential trend change.

Or, set a target for risk multiples. If your trading risk is $0.14 per share, your goal is to make a profit twice your risk (or $0.28). For example, the above short trade started at 33.37 USD and the stop loss order was 33.51 USD. The distance between entry and stop loss is $0.14. Therefore, the goal is to earn at least $0.28 in trading (twice the risk) by placing the target of $0.28 below the entry price of $33.09. The double risk multiple can be adjusted according to volatility. In a very strong trend, the profit may even be equal to three or four times the amount of risk.

If the volatility of ETN is not enough to easily generate income, which is twice the risk you are taking, please avoid trading until the volatility increases.

When the VXX is stronger and the S&P 500 is weaker, the same method applies. VXX will go higher; waiting for callback and pause/consolidation. Then, when the price breaks the top of the consolidation, enter a long position. Place a stop loss order below the callback low.

Frequently asked questions about VXX such as day trading volatility ETF and ETN

What is VXX ETN?

VXX ETN is based on VIX-Chicago Board Options Exchange Volatility Index. VIX reflects investors’ expectations of the short-term direction of the Standard & Poor’s 500 index by evaluating the current prices of put options and call options related to the widely watched index. VIX made educated guesses about the extent of possible changes in the index in the next 30 days. Traders who want to profit from betting on market volatility may invest in VXX.

What does VIX high mean?

The VIX or Volatility Index measures the volatility of the stock market. When VIX is high, it means high volatility. High market volatility is usually accompanied by market fear.

Are ETFs suitable for day trading?

Exchange-traded funds (ETFs) have become another tool of choice for day trading. ETFs provide diversification of mutual funds, high liquidity and real-time trading of stocks, and low transaction costs.

How long does it take for ETF transactions to be settled?

ETF transactions usually take two working days to settle (the trading day plus two working days).

Bottom line

Volatility ETFs and ETNs are generally more volatile than the S&P 500 index, so they are very suitable for day trading. The greatest opportunity (in terms of percentage change in price) occurs during and shortly after the S&P 500’s sharp decline. Volatility ETN, such as iPath S&P 500 VIX short-term futures ETN, may even herald what the S&P 500 will do next.

However, exiting all trades when the market is not good for you is a good way to limit risk. The profit should be greater than the loss. In this way, even if only half of the trades are winners (reaching profit targets), the strategy is still profitable. If, based on the volatility of the day, you cannot reasonably expect to obtain a profit that is at least twice your risk, then please do not trade this strategy.

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