How to Day Trade Volatility ETFs

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How to Day Trade Volatility ETFs

Volatility exchange traded funds (ETFs) and exchange traded notes (ETNs) might provide attractive day trading possibilities at times, while volatility ETFs should be avoided at other times. A volatility ETF often moves in the opposite direction of major stock market indexes like the S&P 500 or the Dow Jones Industrial Average.

When the S&P 500 is increasing, volatility ETFs and ETNs, such as the iPath S&P 500 VIX Short-Term Futures ETN (VXX), often fall. Volatility ETFs and ETNs, on the other hand, often increase when the S&P 500 falls.

Key Takeaways

  • Day trading volatility exchange traded funds (ETFs) might be appealing at times, while volatility ETFs should be avoided at others.
  • An ETF is an exchange traded fund that invests in underlying assets.
  • An ETN is an exchange-traded note that is designed as a debt product and does not hold any assets.
  • Volatility ETNs, such as VXX, often “lead” the S&P 500; when this happens, the signal tells you whether to go long or short.
  • When the S&P 500 falls, VXX frequently experiences dramatic movements, and the moves in VXX typically considerably surpass the change in the S&P 500.

ETFs vs. ETNs

Although they are all referred to as volatility ETFs, some are real ETFs while others are technically volatility exchange-traded notes (ETNs).An ETF is a fund that trades on stock markets and owns underlying assets. An ETN is a kind of exchange traded note that trades on exchanges but is designed as a debt product and does not hold any assets.

ETNs do not have the tracking mistakes that ETFs have since they just monitor an index. ETFs, on the other hand, invest in assets (often those in a benchmark index), and the value of such assets may differ from the index itself. When divergences occur, they may cause performance disparities between the ETF and the index it is designed to reflect.

Nonetheless, ETFs and ETNs are both appropriate for day trading volatility as long as the ETF or ETN being traded has a high level of liquidity, as indicated by trading volume or the number of shares moved each day.

Choosing a Volatility ETF/ETN

There are many volatility exchange-traded funds, including inverse volatility ETFs, to pick from. In general, an inverse volatility ETF will move in the same way as major stock market indexes (the inverse/opposite direction of standard volatility ETFs). A basic ETF/ETN with high volume is typically the best option for day trading. The iPathS&P 500 VIX Short-Term Futures ETN (VXX) is the most liquid and biggest volatility ETF/ETN.

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The iPath S&P 500 VIX Short-Term Futures ETN’s one-year daily total return (as of Apr. 24, 2022).

Best Times to Day Trade Volatility ETF/ETNs

When the S&P 500 falls, VXX frequently sees explosive movements. VXX’s movements often outstrip those of the S&P 500. A 5% loss in the S&P 500, for example, may result in a 15% gain in VXX. As a result, trading VXX has a higher profit potential than merely shorting the SPDR S&P 500 ETF Trust (SPY).Because VXX has a propensity to “overshoot” on dips in its benchmark, the Standard & Poor’s (S&P) 500 Index, when the S&P 500 rebounds, VXX often sells off sharply.

Day traders have two ways to profit:

  • When the S&P 500 is falling, buy VXX.
  • Short VXX after a price increase, when the S&P 500 starts to rise again and VXX falls.

Depending on the strength of the S&P 500 trend, good trading circumstances in VXX may last several days to many months. The chart below depicts the S&P 500’s short-term dip and reversal, as well as the accompanying surge and selloff in VXX.

Image by Sabrina Jiang © Investopedia2021

The figures demonstrate that VXX has a propensity to overshoot; the ETN soared 105% despite the S&P 500 declining 11.84%. It subsequently plunged 31.6% after the S&P 500 recovered 10% from its low. These are the instances when day traders will wish to trade VXX.

VXX will fall slowly when the S&P 500 is in a calm rally with no negative movement. Day trading is not recommended at these periods. The best possibilities arise during and after a multiple percentage point drop in the S&P 500.

Day Trading Volatility ETFs

Volatility ETFs or ETNs, such as VXX, often “outperform” the S&P 500 Index. This helps you know which side of the deal you want to be on (long or short).The charts below, for example, showed multiple indicators that the S&P 500 would rise.

The VXX (top chart) was lower in the morning, even though the S&P 500 (bottom chart) had a lower low. Then, just after 12 p.m., VXX broke through its main support level, signaling that the S&P 500 might ultimately break through its resistance level. About 30 minutes later, it did.

Image by Sabrina Jiang © Investopedia2021

VXX will not always outperform the S&P 500. The S&P 500 can sometimes lead, which can offer us with signals for day trading VXX. When there is a substantial loss (or subsequent rise) in the S&P 500, the greatest intraday chances in VXX occur. During such circumstances, utilize the following entry and stop to benefit from the volatility ETN.

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The graphs below serve as an example. The S&P 500 (bottom chart) has recently recorded a lower low and is now rallying. VXX (top chart) is also far below its peak and establishing a sideways channel (highlighted by the rectangle on the chart).The S&P 500 continues to rise. A day trader should now be able to piece together that VXX is weak (lower low) and that if the S&P 500 is climbing, VXX is going to drop shortly.

Keep an eye out for a trade trigger. This is an occurrence that indicates that the price is beginning to fall. VXX is either trading in a channel or undergoing a minor consolidation over $33.38. If the price falls below $33.38, the channel is broken, and given the other data, a short trade in VXX is possible.

Image by Sabrina Jiang © Investopedia2021

To protect the short position, a stop-loss order at $0.02 above the most recent high (which happened immediately before to entrance) seems reasonable. A trader should set a stop-loss order at $0.02 below the most recent low that occurred shortly before to entry if going long.

Exit trades if you sense the market’s broad trend changing against you. A higher swing low or higher swing high signals a probable trend change if you are short. A lower swing low or lower swing high signals a probable trend change if you are long.

Set a goal that is a multiple of the risk instead. If your risk on a deal is $0.14 per share, try to earn twice as much (or $0.28). For instance, the aforementioned short trade was launched at $33.37 with a stop-loss order at $33.51. The spread between the entry and the stop loss is $0.14. As a result, strive to earn at least $0.28 on the trade (two times the risk) by setting the objective at $33.09. This risk-to-reward multiple may be adjusted dependent on volatility. Profits might be three or four times the amount at risk in extremely strong trends.

If the volatility ETN isn’t moving fast enough to readily earn profits equal to double your risk, stop trading until volatility rises.

When VXX is strong and the S&P 500 is weak, the same strategy is used. VXX will rise; look for a pullback and a halt or consolidation. Enter a long position when the price breaks above the top of the consolidation. Set a stop-loss order slightly below the pullback’s low.

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Day Trade Volatility ETFs and ETNs Like VXX FAQs

What Is the VXX ETN?

The VIX—the Chicago Board Options Exchange Volatility Index—is the basis for the VXX ETN. The VIX indicates investors’ views about the S&P 500’s short-term trajectory by analyzing current pricing for put and call options on the widely watched index. The VIX provides an informed forecast as to how much the index will change in the following 30 days. Traders who seek to benefit from market volatility bets may consider investing in the VXX.

What Does It Mean When the VIX Is High?

The VIX, or volatility index, gauges stock market volatility. When the VIX is high, this indicates that volatility is high. Market fear is frequently associated with high market volatility.

Are ETFs Good for Day Trading?

ETFs (exchange traded funds) have developed as another popular vehicle for day trading. ETFs provide mutual fund diversification, stock liquidity and real-time trading, and minimal transaction costs.

How Long Does an ETF Trade Take to Settle?

A typical ETF transaction takes two business days to settle (trade date plus two business days).

The Bottom Line

Volatility ETFs and ETNs feature greater price fluctuations than the S&P 500, making them excellent for day trading. The best possibilities (in terms of percentage price changes) occur during and immediately after big drops in the S&P 500. A volatility ETN, such as the iPath S&P 500 VIX Short-Term Futures ETN, may even predict what the S&P 500 will do next.

Exiting all deals when the market swings against you, on the other hand, is an excellent approach to reduce risk. Profits should outnumber losses. This manner, even if only half of the transactions are successful (the profit objective is met), the strategy remains lucrative. If you can’t fairly anticipate to make at least double your risk based on the volatility of the day, don’t trade this approach.

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