How To Trade Where The Action Is…Every Day
As a trader, you want to
maximize your profit potential on every trade. One way to do this is
to only trade stocks that are capable of making substantial moves. Even if you
are successful in predicting the direction of a move, unless you get meaningful
movement, you won’t be getting the most out of your trade. As a trader, your
profits are limited to the amount a stock can move, so finding the most volatile
stocks is imperative.
Daytraders: You want to find the stocks
with the greatest intraday range — you don’t necessarily care about the
direction.
Swing Traders: You want stocks capable of
making a large, trending move over a period of a few days.
Options Traders: You’re looking for a
fast, explosive move before time value gets the best of your position.
Intermediate Term Traders: These stocks
offer you great potential if any of them meet your unique fundamental and
technical criteria.
Q:
How can you make sure you’re in stocks that
have the likelihood of making substantial moves? Â
Each day, we generate this powerful list which
shows the most volatile stocks over the past 50 trading days. Volatility can be
one of your most important trading tools. Using volatility to determine how much
price will move allows you to determine if a stock should be traded or not. A
little unclear on volatility? No problem.
Quick Volatility Refresher
You don’t have to know how volatility
is calculated in order to benefit from this list, but it helps to understand
how it works.
Simply put, volatility measures the
change in price of a market over a given time period. In non-technical terms,
think of it this way: If the Nasdaq rises 5 points one day and falls 5 points
the next, volatility is low. If, however, it rallies 100 points one day and
plunges 100 points the next, then volatility is high. More specifically,
historical volatility (HV) is the standard deviation of the day-to-day price
changes, expressed as a percentage. A $100 stock with a 10% historical
volatility has a 66% chance of trading between $90 ($100 – $10) and $110 ($100 +
$10) over the next year.Â
Here’s a quick calculation from Dave
Landry’s volatility lesson:
- Divide today’s close by yesterday’s
close - Take the natural log of #1
- Take the standard deviation of #2
for length desired (the number of trading days, e.g. 50) - Multiply #3 by 100
- Multiply #4 by the square root of
trading days in 1 year (around 256)
More Potential, But
More Risk Too
Day, option, and swing traders
especially will want to seek out more volatile stocks. Because of the large
intraday ranges these stocks trade in, they can provide good profit potential —
and more risk. By definition, stocks with higher HV are riskier than those with
a low HV. Intermediate-term traders, be advised that because of the larger
ranges, there is increased potential to be stopped out. Adjust your stops
accordingly. One idea is to base your stops around the historical volatility.Â
Again, from Dave’s lesson, here’s a calculation of the stop points:
- Divide 260 trading days by the
number of days you intend to hold the position - Take the square root of #1
- Divide the historical volatility by
#2 - Take the stock price and add (for
shorts) and subtract (for longs) #3 from it
The Proof Is In The
Charts
Below are three stocks that came up on
“Trading Where The Action Is” –Â notice the kinds of moves these
volatile stocks can make.
Marvell Technology
(
MRVL |
Quote |
Chart |
News |
PowerRating)
explodes in a seven-day run after making the “Trading Where the Action
Is” list on 10/31/01.
Brocade
(
BRCD |
Quote |
Chart |
News |
PowerRating) follows suit, with
an equivalent gain.
Not to be outdone, RF Micro Devices
(
RFMD |
Quote |
Chart |
News |
PowerRating)
takes off for a 36% gain in a few days.
While these stocks were taking off, so was the
Nasdaq — but as expected, the NDX didn’t perform as well as the more volatile
stocks — up only 13%. The S&P (not pictured) performance for the same
period was even less. No doubt one could have made money in the run-up shown
above, but wouldn’t it have been better to have been in the exploding stocks?
To find “Trading Where The Action Is”
from the TM Home Page, click
on Stocks, then Indicators,
scroll to the bottom, and under “Actionable
Signals And Other Indicators,” click on “Trading
Where The Action Is.”Â
When you get there, you’ll see the list of stocks
in order of volatility, with a chart option, sector, volume, earnings, and
relative strength data to to help you further refine your research.
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How To Use The List
Pull up a chart for each stock and identify the
current trend. Evaluate the stock’s strength through the use of its 3-, 6-, and
12-month Relative Strength rankings. Short-term traders will probably care more
about near-term RS. If you are directional trader, use the Stock
Scanner to determine the strength of the trend. Look for key pattern setups
such as pullbacks and trading-range breakouts as well as large surges in volume.
When you see the stock set up, you’ll have the confidence that it has the
“juice” to make a good move. Use entry points as defined by the setup
rules.
Volatility is one of a trader’s best friends —
use it to your advantage. Filter out low-volatility stocks by clicking Trading
Where the Action Is every day, and focus only on the big movers that
will give you the big trades.
For a more detailed study of volatility, see Larry
Connor’s lessons on the subject, his books Street
Smarts and Connors
on Advanced Trading Strategies, and Dave Landry’s three lessons: 1Â Â
2Â Â
3.
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