VIX regimes and sector rotation
Lesson 7 · about 10 min
The trend filter says which direction, breadth says how many participants. Two more readings finish the picture: how violent the market is (volatility) and where the money is going within it (rotation). Both change how you size and which setups you pick.
The VIX as a regime dial
The VIX measures the implied volatility of S&P 500 options over the next 30 days. You do not need to understand the calculation. You need to know that it translates roughly into an expected daily range for the index, and that expected range is the thing that decides whether your stops survive.
A rough conversion: divide the VIX by 16 to get the implied one-day move in percent. VIX 16 implies about a 1% daily move; VIX 32 implies about 2%.
| VIX level | Implied daily index move | Regime label | Swing-trading adjustment |
|---|---|---|---|
| Under 15 | ~0.9% | Quiet | Full size; breakouts and pullbacks; tight stops work |
| 15 to 22 | ~1% to 1.4% | Normal | Full size; standard stops |
| 22 to 30 | ~1.4% to 1.9% | Elevated | Half size; widen stops by roughly 50%; expect failed breakouts |
| Over 30 | ~2%+ | Stress | Quarter size or cash; reclaim setups only; no fresh breakouts |
The size adjustment is not caution for its own sake. If the index is moving 2% a day, a stock that usually moves 2% is moving 4%, and a stop set for a normal day gets hit by noise. You either widen the stop and shrink the size to keep the dollar risk constant, or you stand aside. What you must not do is keep the normal stop and the normal size.
VIX 14: daily bars VIX 34: daily bars
| | | | | | |
| | | | | stop 4% away | | |
survives | | | | stop 4% away
| | | | hit on day 2 by noise
Crypto has its own volatility indices and forex has implied vol on the majors; the same logic applies. When implied volatility is in its upper quartile for that market, halve size and widen stops.
Rising VIX vs high VIX
A high but falling VIX is the recovery regime and is often a good time to start buying reclaims. A low but rising VIX from a very low base is the early warning that a quiet uptrend is about to get harder. Note the direction of the last two weeks as well as the level.
Key idea: Volatility sets the noise level. When the VIX rises, keep the dollar risk constant by widening stops and shrinking size, or step aside, but never keep both the tight stop and the full size.
Sector rotation
Within any index regime, money moves between groups. In an uptrend, some sectors lead and some lag; in a correction the rotation is often into defensives. A swing trader who is long the lagging group in a healthy market will underperform badly and conclude the method is broken when the method was fine and the group was wrong.
The simplest way to read rotation is a relative-strength ranking of sector ETFs or sector indices against the broad index over the last one and three months.
| Step | What to do |
|---|---|
| 1 | List the 11 sectors (or the equivalent groups in your market) |
| 2 | Compute each sector's return over 1 month and 3 months |
| 3 | Subtract the index return over the same periods |
| 4 | Rank by the 1-month relative return; note which are also positive at 3 months |
| 5 | Trade long setups only in the top 4 sectors; avoid the bottom 3 entirely |
A sector that is top-four on both windows is a leader. One that is top-four on one month but bottom on three months is an early rotation candidate: potentially the best setups, but also more likely to fail, so start at half size.
Why rotation matters more than it looks
Individual stock setups look identical across sectors. A breakout is a breakout. But the same pattern in a leading group has institutional buying behind it and in a lagging group it has institutional selling above it. Tagging trades by sector rank in your journal usually shows a wide gap in follow-through between the top and bottom groups. It is one of the cheapest edges available to a swing trader, and one of the most ignored.
Combining the four readings
By now the weekend regime check has four inputs: trend filter, breadth, VIX, and sector rotation. The next lesson turns them into a single checklist with a size multiplier. For now, note the pattern: each reading can only reduce what the filter allowed, never increase it. An uptrend with bad breadth is a narrow uptrend. A narrow uptrend with VIX over 30 is a market to watch from cash.
Try it: Compute the 1-month and 3-month returns of the 11 US sector ETFs (or your market's equivalent) relative to the index. Rank them. Then look at your last ten long trades and note which sectors they were in. If most were in the bottom half of the ranking, you have found a free improvement.
Recap
- VIX ÷ 16 gives the rough implied daily index move in percent.
- Under 22 is normal; 22 to 30 means half size and wider stops; over 30 means quarter size or cash.
- Keep dollar risk constant when volatility rises by widening the stop and shrinking the size together.
- Rank sectors by 1-month and 3-month relative return; take longs only in the top four.
- Each regime reading can only reduce what the trend filter allows, never increase it.
See it drawn
Original diagrams for the ideas on this page. Illustrative, not real market data.