Track Risk Index – India VIX for fall relief

Are we at the bottom yet? This is the question on everyone’s mind when we are in a falling market. There are multiple studies that are built around detecting bottom. We will look at one of the data points that tracks trader’s expectation to identify a point of immediate relief.

The objective is to find out when the market will stop falling. However, before we do that, let us understand the data point that will lead us to this expectation. India VIX also known as Risk Index is that single data point that can help us find out the shift in traders’ mindset as it happens.

Let us understand what India VIX is. This will help us lead towards the why and how India VIX is an efficient data point to do so.

India VIX is a proxy index and is indicative of expected volatility priced in the Options of Nifty index. The reason this is called a risk index is the very nature of the volatility. There is no rocket science in understanding that Market will be highly volatile when it falls, and it will be slow and less volatile when it rises.

Using the same relationship, we can establish that high volatility means high risk of fall and low volatility means low risk of fall. Hence, we call India VIX a Risk index as well.

Now why to use India VIX has two-part explanation over and above its definition. Firstly, India VIX is made up of Nifty Options’ volatility expectations. Nifty being constructed out of 50 biggest companies; the expectation is for 50 biggest companies combined. Secondly, Options price has expected volatility and not existing volatility. So, fall in future expected volatility directly corelates to stoppage of fall.

Before we see how to use India VIX in building expectations about stop of fall, let us look at the chart of India VIX plotted against the Nifty future for last few weeks.

Primary observation or more importantly validation one can make is the negative relationship between Nifty Futures and India VIX. Majority of temporary tops of India VIX are coinciding with majority of temporary bottoms of Nifty. This is the reason why one should track what India VIX is doing especially while market is falling.

Now that we have established the what and why of India VIX’s importance in tracking temporary bottom in the index, let us understand the how.

This is not an exact science, but it has worked for me almost all the time. India VIX like any other range bound indicator moves in the range. It has smaller and frequent tops and bottoms. All I do especially in falling market is, look for a newer top. As soon as a newer high is posted, I wait for a day of fall in India VIX. That is the day of high probability temporary bottom formation, whatever the price may be.

Some of these newer tops are highlighted in the chart above to reinforce the temporary bottom formations. Now, how to trade such expectation is all together a topic of another discussion.