If you’re looking for a market event to trade in the first week of 2017, look no further than the US non-farm payrolls release. This report is due on Friday’s New York trading session and may provide a lot of volatility for dollar pairs such as EURUSD or USDJPY. Another alternative instrument to trade is the VXX or the volatility index.
What is the VXX?
The volatility index tracks the magnitude of the price movements of the S&P 500. In particular, it measures expectations for the US stock index over the next 30 days and is dubbed as the ‘fear index.’ This is calculated by the Chicago Board Options Exchange or CBOE and is used as an underlying component for futures and options.
A higher VXX reading means that fluctuations were larger or more volatile while a lower reading means that these movements were smaller. Simply put, an increase in the VXX reading reflects investor fear or uncertainty while a decrease means that risk appetite is present. VXX isn’t necessarily a gauge of direction, though, as it indicates perceived volatility whether to the upside or downside.
Onto the December non-farm payrolls report. Analysts are expecting to see a 178K increase in hiring for the month, lower than the earlier 178K rise. Still, a higher than expected read may remind traders that the Fed is on track towards hiking interest rates three more times this year while a lower than expected result may cast doubts on this timeline.
Higher interest rates may dampen business investment and consumer spending since it lifts overall borrowing costs in the economy. As such, it may to have a bearish impact on stock indices. On the other hand, expectations of no changes in monetary policy may keep equity markets in the green. But depending on which phase the US economy is in, upbeat NFP results may also mean strong gains in equities as a stable jobs market might be positive for corporate America.
How to trade the VXX
Since the VXX reflects the perceived volatility in the S&P 500 index, its movements may hinge on how much the actual figures surpass or undercut expectations. A significantly stronger than expected read may still lead to a spike in the VXX as this might put the odds of a Fed rate hike higher in the first or second quarter of the year, and this may have a major impact on stock prices in the near term. Similarly, a very downbeat reading may also trigger a huge reaction from the VXX since this may dampen rate hike hopes in the coming months.
More conventionally speaking, a higher VXX is associated with a sharp decline in the markets while a lower VXX may be indicative of a steady bull market. In this particular scenario, a reading above 250K may lead to a sharp S&P 500 selloff in anticipation of a Fed rate hike while a reading below 100K may also lead to equity losses on a sudden downturn in employment. On the other hand, a reading in line with expectations or somewhere between 150K-200K may keep a lid on the VXX or even pull it down.
On the easyMarkets platform, the VXX is also shown as a regular candlestick chart with multiple time frames. Various indicators can also be applied to gauge where the index might be headed next, although it’s worth noting that large gaps can be seen during market opens or when top-tier US reports are released.
It is treated as a CFD or contract-for-difference, which settles the price difference without the physical exchange of assets. With volatility as a central feature of financial markets, easyMarkets enables its clients to trade volatility as an asset.
The VXX CFD allows traders to bet on the direction of stock markets and can also be used to hedge existing positions. For instance, if you are currently long on US equity indices but you expect a sharp dip following the NFP release, you can also put a long position on the VXX. In other words, taking a long VXX position means that you are betting on weaker stock performance while going short VXX means that you are betting on stock market gains.
The VXX can also be used as an indicator itself in the same way as oscillators reflect overbought or oversold conditions. High VXX values can be treated as an oversold indicator as it creates investor biases against sell setups and being more interested in going long. Low VXX values can be seen as an overbought indicator, reflecting caution on buy setups and preference towards shorting.
In short, the VXX is seen to be negatively correlated to stock markets and may be used to make quick profits off potentially volatile market scenarios. These scenarios may occur during the release of top-tier data, which might generate large market reactions in the short-term before the trends are smoothed out later on. Large VXX spikes were recorded in the EU referendum, the US elections, the OPEC meeting, and other high-profile events that tend to make investors anxious.
The VXX has traditionally spiked around NFP day as investors are feeling anxious about the results of the report. Putting this knowledge to use suggests that may exist better odds of success by going long on VXX during the day of the release as the actual results are rarely in line with consensus. Another way to trade the VXX after the NFP release is to short it once markets calm down afterwards. Keep in mind also that VXX trades against the direction of the S&P 500 about 75-80% of the time.
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