Today’s Trading Lesson From TradingMarkets

It is difficult to make money in markets that have small daily ranges because
the spread, slippage and commission (“the take”) on a percentage basis of your
likely move is too large. That’s why you need to be in markets that have large
daily ranges to help minimize these inherent costs.

Let’s look at what you can likely expect on a daily basis using volatility as
your guide. For example, Wednesday night, pork bellies had a 50-day historical
reading of 41%. This means (assuming volatility remains the same) that bellies
have a 2/3 chance of closing within 41% above or below today’s price, one year
from now. Let’s assume that bellies are at $.60. Historical Volatility tells us
that there is a 67% chance that prices will be between $.36 and $.84 a year from
now.

As short-term traders, we obviously want to know where prices will be over
the next few days, not a year from now. Let’s use the very volatile stock
Knight/Trimark (NITE) and ask where it will likely close five days from today.
Let’s assume its price is $150.00 and its volatility is 153%. The formula is:

• Step 1: Take 260 trading days and divide it by 5 trading days, which
  equals 52.
  
  
• Step 2: Take the square root of Step 1 and you get 7.2.
  
  
• Step 3: Divide the stock’s current volatility of 153% by Step 2 = 21.25.
  
  
• Step 4: Add 21.25 to the stock’s current price and you get 171 *.

  Subtract 21.25 from the stock’s current price and you get 128 *.

This now tells us that if volatility remains basically unchanged over the
next five days, the stock has a two out of three chance of closing between 128 *
and 171 *. In Tuesday’s column I will show you how to apply this information to
your day-to-day trading.