*A mechanical trading strategy utilising macroeconomic data influencing VIX futures contracts*
This is the 4th and final “episode” in the Trading Market Volatility series. In this blog post I am going to share with you my full and complete High Impact US Employment Data (NFP) Trading Strategy. This is taken directly from my Mastering The Markets – Retail Trading Course which is available for purchase on the Financial Analysis Education page of this blog.
High Impact US Employment Data (NFP) Trading Strategy.
I am now going to show you a trading strategy that I have found to work very well when trading a particular high impact economic news event. This strategy is based on using a bespoke US volatility index and the relevant futures contracts to trade the Non-Farm Payroll (NFP) report which is a key economic indicator for the United States.
Non-farm payroll is the sum of all paid employment outside of the farming and agriculture industry. It also excludes some government workers, private households and non-profit employees. NFP is said to be one of the most consistent economic data releases to move the financial markets and is heavily watched and traded because of it is an indication on the economic strength of the largest economy in the world, the United States of America.
NFP data is released at 08:30am EST on the first Friday of every month.
“The non-farm payroll report causes one of the consistently largest rate movements of any news announcement in the forex market. As a result, many analysts, traders, funds, investors, and speculators anticipate the NFP number and the directional movement it will cause. With so many different parties watching this report and interpreting it, even when the number comes in line with estimates, it can cause large rate swings.” – Investopedia.
This trading strategy is purely mechanic and based on trading a regularly occurring pattern that presents itself once per month when the NFP report is announced. This strategy can be used alongside your normal regular day trading and swing trading to potentially increase your annual returns on capital.
Chicago Board Options Exchange Volatility Index (VIX)
The VIX Index is a calculation designed to produce a measure of constant, 30-day expected volatility of the U.S. stock market, derived from real-time, mid-quote prices of S&P 500® Index (SPXSM) call and put options. On a global basis, it is one of the most recognized measures of volatility – widely reported by financial media and closely followed by a variety of market participants as a daily market indicator.
In simple terms, the VIX produces a tradable value for the amount of short-term implied volatility on the US Stock market, in particular the S&P 500 index. To learn more about the CBOE Volatility Index (VIX) please click on the following link. http://www.cboe.com/vix
I am yet to come across a retail trader who understands or uses the VIX in their trading strategies. This is why I believe this trading strategy can give you a real edge over other retail traders who solely trade the forex and derivatives markets because trading the VIX can be used within many different trading strategies as shown in the image below taken from the CBOE website.
This trading strategy is going to be taking advantage of the ability to use the VIX for trading long/short Volatility in the short term.
Strategy set up.
You will need access to a live price feed for the VIX along with the ability to place short positions on VIX futures contracts. You can then look at the lower timeframe chart for these contracts to observe how price has reacted to the NFP data releases for previous months as this proves the potential for long term success by using this trading strategy.
I have to use a separate trading account with a different broker to trade the VIX so it is important to know that you may need to allocate some of your capital to an extra trading account if you want to trade this strategy. My capital allocation techniques are explained in more detail in section 7, capital allocation.
Theoretically you do not need a trading price chart to trade this strategy once you know how to place your trade orders prior to the NFP announcement. However, for the sake of learning and understanding how and why this strategy works, I advise you to open the VIX price chart and load it with the 5-minute and/or 15-minute timeframe price data in candlestick format.
For the purpose of this trading strategy, the chart is only needed for your own back testing in order to prove that this strategy has the potential to work, it is profitable and to show you how short-term volatility is affecting by the release of NFP data.
Important! The CB_VixFix is a custom indicator I created and use for monitoring the changes in levels of market volatility on any timeframe. It is not necessary for this strategy but it can be found on the TradingView platform.
The main premise behind this trading strategy is that short-term implied volatility actually decreases after high impact economic is released because a level of uncertainty has been removed from the markets now the actual results of the data have been confirmed. In this case employment data. This is similar to the age-old quote:
“Better the devil you know than the devil you don’t”.
In the lead up to key data releases, the VIX will get its values from the volatility expected by traders for the next 30 days. If a high impact data release like NFP is expected then VIX will be trading higher because there are levels of uncertainty implied from the, as yet, unknown employment data figures.
I have found that for the majority of NFP releases, it is possible to profit from the change in levels of expected uncertainty as displayed by the VIX. Once the high impact data is actually released to the markets, the levels of short-term implied volatility is reduced because the unknown data is now known and the financial markets can deal with it. It does not matter whether the employment figures are positive or negative for the economy or whether they are better or worse than expected. When the data is released, traders, investors, business owners and governments can deal with the figures and uncertainty is reduced because the markets move in a single direction based on the employment figures released.
The levels of volatility displayed on the VIX are caused by market participants not knowing which way the financial markets might move. This is the uncertainty which is then removed when a prevailing market directional bias is found when the employment data is released. Therefore, reducing volatility.
The main benefit for trading the VIX instead of the US Dollar or stocks or fixed income instruments is that instead of trying to predict the upcoming employment data figures, you can trade the almost guaranteed outcome that implied volatility will be reduced in the short term. Your potential returns are then governed by how much the VIX drops after the NFP data is released.
When comparing trading the VIX vs trading the US Dollar currency around the NFP data announcement, the VIX is far simpler and easier to trade.
If you are planning on trading the US Dollar you need to do the following:
1. Decide how the market is pricing in the data release to see whether positive or negative figures are expected.
2. Enter your trade position based on this bias.
3. Wait for the data to be released.
4. You will only profit if your directional bias is correct and the market moves in that direction without first reaching your stop loss order.
If you are long USD but the employment data is negative then you will lose. If the employment data is positive but not as good as expected/priced in then you will lose. If the initial reaction is negative but long term positive, you will likely lose.
If you are short USD but the employment data is positive then you will lose. If the employment data is negative but not as bad as expected/priced in then you will lose. If the initial reaction is positive but long-term negative, you will likely lose.
To profit from your bet you have to have a stop loss order that avoids any price spiked leading in to the data release, you must have the directional prediction correct and account for any pricing in that has occurred.
This also excludes slippage and variable spread fees that will affect your profitability if you are trying to exit trade positions around the time of the data release. Your stop loss order could not be triggered at your desired price level and therefore you will be over exposed. You could also successfully predict the directional bias but again, slippage and spreads can affect your profitability when exiting a winning trade position.
If you are trading the VIX then all you need to do is:
- Enter a short position on the VIX futures market prior to the data release.
- Wait for the data to be released.
- Profit when short term implied volatility is decreases.
If you are short VIX and the employment data is negative then you should win. If the employment data is positive but not as good as expected/priced in then you should still win. If the initial reaction is negative but long term positive, you should still make profit because all of these result in the increase of information available to the market and therefore short- term volatility decreasing.
It may take you a while to understand the theory behind the trade but please read through the full strategy and look at the trade examples and data I am about to show you. It will help you understand why this trade works a lot of the time.
Here is the process for how and why I enter and manage the short position.
1) Enter 15 minutes prior to the data release. This will be 08:15 EST or 13:15 GMT. The reason for this is to avoid the potential increase in spreads introduced by the broker which is common around times of high impact data releases.
2) Place your stop loss 0.2 points above the entry price. This was determined from my back-testing data which you can see below. It allows for the VIX to “breathe” whilst maintaining a good reward:risk for the short positions.
3) Hold VIX short position through the remainder of the trading session.
4) Close VIX short positions before the Friday market close to avoid risk of weekend
market gaps against your position and weekend positional holding costs.
Back testing data.
I have back tested my strategy using the data made available to me through my TradingView charting software. I have analysed the previous 21 NFP data releases to establish that this strategy is profitable.
The table below shows a summary of my findings.
I have provided 2 profit taking options because I was also keen to find a method that allowed the trader to not be present at the market close in order to close the short positions. If this is required then instead of manually closing the position you can set a profit target order at 2x risk value or 0.4 points below the short position entry price. If this profit taking order is not hit in the first 15 minutes after the NFP data release then the short position must be closed manually at the close of that 15-minute candle.
By using this method, you actually increase win rate of total trades from 62% to 86%. However, the total return (R) is then reduced from 66.3R to 31.5R. This is a by-product of reducing the trader input.
The following table shows the complete price data for each of the 21 trades with the returns and loss for each method of profit taking.
Important! All price data shown in back-testing data excludes costs of trading such as price spread and slippage.
I will now show you a selection of trade examples with price charts and trade data to show you when the strategy works and when it doesn’t. All of these trade examples are using the method of holding positions until just before the Friday market close.
Important! You can find more trade examples for this strategy in the Trade Database folder within the Mastering the markets retail trading course materials.
Trade Example 1: CBOE VIX Futures – 01/11/2019
Short entry price @ 13.00. Stop loss order @ 13.20. Trade close price @ 12.30. Final return = 3.5R
Trade Example 2: CBOE VIX Futures – 04/10/2019
Short entry price @ 19.90. Stop loss order @ 20.10. Trade close price @ 17.00. Final return = 14.5R
Trade Example 3: CBOE VIX Futures – 02/08/2019
Short entry price @ 18.10. Stop loss order @ 18.30. Trade close price @ 18.30. Final return = -1R
This is strategy is based purely off of past NFP data releases that I have been able to observe and record the price movements of. I have been unable to get access to historical data for more than 2 years ago to get a bigger picture of whether this strategy is profitable for more than the past 2 years. Therefore, it could be the case this this strategy only works at certain times within the larger financial market cycles and it could become unprofitable in the future.
The other limitation is that this strategy will only work in the immediate short term after the NFP data is released. It relies on the fact that implied volatility (uncertainty) is reduced thanks to increased knowledge of the economy from the release of the employment figures. However, once the figures are digested and market participants begin to create their longer- term opinions on the strength of the economy, uncertainty could begin to rise.
You will occasionally enter unprofitable positions (based on back testing data). This is when short term volatility does not decrease because of external factors having a greater influence over market participants views than the release of high impact employment data. However, I have designed this strategy to produce trades with a potential return of 2R which allows for losing trades to be entered whilst long term profitability remains.
If you are interested in learning my personal trading strategies, please consider my Mastering The Markets – Retail Trading Course. Head over to my Financial Analysis Education page to check out all of my education packages and the deals available.
All my technical analysis is done using the TradingView platform. You can get access via the link below.
My preferred broker of choice is IC Markets. Low spreads and trading costs really help long term profitability. A link to their site is below.
FTMO Trader Funding Programme.
Thanks for reading and please don’t forget to LIKE, SHARE and FOLLOW my blog to stay up to date with the latest market analysis and trading education posts.
DISCLAIMER: None of the information posted on this site is to be considered investment/financial advice. Trading is high risk and you should only trade with money you can afford to lose.