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Frequently Asked Questions

Dr K VIX Volatility Model
What are the potential weaknesses of the model?

First, please read this important update: http://www.virtueofselfishinvesting.com/reports/view/vix-volatility-model-vvm-important-update-5-16-17

While the model has a number of triple digit percentage gains (>100%) in a year's time based on backtests, and it has hugely outperformed the major indices each year since backtests began in January 2009, here are its potential weaknesses:

• The model could get whipsawed a number of times via its fail-safes should the ETF go into a trading range while the model stays on its signal. That said, each signal has a maximum of four losses in total that are allowed then it moves to cash until the next change in signal. 

• Based on backtests and real-time trading, the maximum fail-safes are triggered roughly 11% of the time, thus profits shown in backtests have far outweighed such infrequent events.

• The model's worst drawdown is 40.9% in 2017 that took place during a volatile phase of the market. Time to recover the losses took just 13 trading days because the model's sweet spot is during volatile markets.

• The problem of the model getting sidelined as the market went higher has been solved with the REBUY RULE (implemented September 2016): After a VIX spike buy signal is closed out, the original sell signal will only be reinstated if the ETF XIV moves in favor of a continued uptrend by a sufficient amount. The risk in reentering this trade will be contained to this amount which should be typically less than 2%. Tests show that one would have often made a handsome profit in such a situation by closing out their sell signal to buy the VIX spike buy signal, then buying back XIV or related ETF on the original sell signal. 

• There is gap up/gap down risk with these volatility ETFs. Should the ETF gap lower the next day triggering a fail-safe, the loss could be greater than the typical 0.5% to 2% using a 1x ETF. Backtests have shown the worst case scenario was an overnight gap down of 22.1% due to Brexit. The rebuy rule reduced the total loss on the trade to 12.2%. The flipside of this are gaps that occur in one's favor. In backtests, such favorable gaps have far exceeded any losses caused by gaps lower through fail-safes.

CAUTION: While VVM has achieved substantial returns, expect sharp moves in your position at times. This can be enough to cause an investor to prematurely sell their position. Smaller positions may be warranted depending on your risk tolerance level (pain point). Also expect a string of false (losing) signals at times. This can be enough to discourage an investor from taking the next change in signal. I know from experience as I overrode the model's signals at some critical times. In working with the model in real-time trading using my own capital, I acclimated myself emotionally to the model's change in signals. I have suggested each member do the same.

IMPORTANT: VVM was up more than 50% the first 10 weeks of 2017, then gave it all back due to a fail-safe adjustment I made. Nevertheless, the adjustment still stands as such performance volatility, while at record levels, can occur, and is not outside the performance metrics for this strategy. The adjustment further boosts reward by a considerable amount while keeping risk at equivalent levels. The only downside is potentially greater downside for a single signal. But the one-off CBOE VIX having one of its worst days in its multi-decade history which caused a big loss for the 4-18-17 signal is not a sufficient reason to remove the new adjustment.

Q: Why cant VVM just switch to cash ahead of such an event?

A: Both real-time and backtests have shown the model maximizes its profits by NOT trying to pick tops or bottoms. VVM can at times switch to cash before such a drop as it has done at times, but that form of insurance comes at a cost. VVM walks the tightrope well as it often avoids getting pushed prematurely into cash while protecting the downside by switching out of its signal if necessary. 

NOTE: While there is no 2x inverse volatility ETF, the reason we use only 1x XIV on sell signals is that volatility can spike overnight without warning on some catastrophic news event which would send XIV gapping lower. Meanwhile, markets generally never "melt-up" by gapping higher overnight by the same order of magnitude. And 2x UVXY would greatly benefit on spikes in volatility as it did on 8/24/15 when it gapped higher overnight by +61.9%. 

My intention in sharing this with you is to make everyone aware of certain negative factors which can occur even if the odds of such occurrences are very low.

Dr. Kacher's backtested (and partial real-time) performance using the VIX Volatility Model:

2009 +178.7%

2010 +518.1%

2011 +274.5%

2012 +289.4%

2013 +103.1%

2014 +161.9%

2015 +589.7%

2016 +61.8% (Time-stamped, real-time trading started uninterrupted on 11-8-16)

2017 -0.9% (as of 5-16-17)

Published: Jun 3 2016, Modified: May 18 2017