How to Use the VIX in Forex Trading

What you should know about high-risk investments

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Volatility Index (VIX) refers to the amount of uncertainty or risk about the size of changes in an asset’s value; higher means that the price can change dramatically over a short time period in either direction and lower means that price remains steady.

VIX refers to the Chicago Board of Options Exchange (COBE) Volatility Index, which is calculated from a weighted blend of prices for a range of options on the S&P500 index. Although it is originally a measure of the implied volatility of S&P 500 index options, it has been widely accepted by forex traders as a key indicator of investor sentiment and market volatility. In this article learn how to use the VIX indicator in Forex trading.

Contrarian Strategy:

High volatility, or high VIX reading, occurs at periods of emotional stress and uncertainty when the market is peaking at panic bottom. Low volatility, or low VIX reading, occurs at periods of emotional calm when market is rising.

Forex Applicability:

It must be remembered that the VIX pertains the volatility of S&P 500 index options, and if you are trading currency pairs from this sentiment indicator, you have to make sure that the currency pairs are at least broadly correlated with the S&P 500. For instance, if the EUR/USD is broadly correlated with the S&P 500, and if the VIX reading is high when both the EURUSD and SP500 are in a bear market, then it could signal that both markets have reached their bottom and may stage a bullish correction at any time.

Source:

CBOE Volatility Index (^VIX)

It looks like this on a 5-day scale:

Note: It is nice to compare the VIX on multiple time horizons as well against different currencies. To compare it with different currencies, at least in a percent basis, type in the currency in the Compare tab.

MT4 Tools:

Here is a link to a blog of a French coder who has made available an indicator that graphically charts the daily values of the CBOE VIX in a sub-window below the currency chart, and somehow works out these values on the smaller time frames, plus conveniently adding fast and slow moving averages to better see the larger VIX trends:

Here is what it looks like:

You may have to carefully go back through the data history to see how the VIX moving averages crossing each other can alert you to potential reversals. If you know MLQ4, you might want to work out this indicator into your existing EA as a possible filter, to see if via back-testing along with different configurations (and MA parameter lengths) it can serve to enhance your EA’s performance.