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Stockscores.com Perspectives
For the week ending November 8, 2003
In this week's issue:
Volatility. It is a very important concept for those using stock charts to find opportunities, but very few investors understand how to use it properly. This week, I examine what volatility is, and some hints on how to use it when trading stocks.
Volatility refers to the price swing of a stock over a time period. The difference between the high and low of trading over a day is the volatility of the stock for that day. A stock that trades between $10 and $10.20 is less volatile than a stock that trades between $10 and $11 in a single day.
You can also think about volatility over a week, a month or even a year long period. The greater the price swing, the greater the volatility in the stock. But what does volatility really represent?
Simply, volatility represents uncertainty. The more volatile a stock's price, the greater the uncertainty that investors have about what the company is worth. Through a stock's trading activity, investors are essentially arguing about what the stock's fundamentals are worth. If the market is not sure, then you can expect a stock's price to fluctuate dramatically.
This concept is important because finding stocks that are showing relatively little price volatility at a specific time means you are looking at a stock trading at a price that investors believe accurately reflects its fundamental value. If the stock is trading with less volatility today than it did in the past, it is probably because the market feels it knows what the company is worth.
This is important because of the message that we get when a stock breaks from low volatility. If the market has a high level of confidence in what the stock is worth, then a break from that low volatility implies that there is a significant change in fundamentals underway. These breakouts tend to represent an opportunity.
When you are looking at stocks on Stockscores.com, you must always keep in mind our three rules. First, the Sentiment Stockscore needs to be 60 or higher. Second, the Signal Stockscore needs to be above 80. Once those two rules are met, forget about the Stockscores and now focus in on the stock chart itself. It is extremely important to look for stocks that are breaking from low volatility, from good chart patterns. If the stock has good Stockscores but is showing more price volatility than it normally does, then it is not likely a good trading opportunity. We want to find stocks that are breaking from a period when investors have a strong consensus on what the company is worth. This occurence points to new fundamentals or a change in psychology that can drive an up trend.Back To Top
My first job was working at K-Mart. One of my duties was to operate the Blue Light Special that came each hour. I would go to the product that was to be discounted, set up the Blue Light, and wait for the announcement over the intercom. Then, I would wait for the hysteria to begin. It would not matter what I was selling, or even if it was a really great deal. As soon as the announcement was made, a small crowd would gather. Soon, the small crowd would grow to a big one, and I would begin to fear that I could not print out discounted price tickets fast enough. I often wondered what would happen if I ran out of discounted price stickers. Would the angry mob provide a twisted demise for a 16 year old guy working a lousy job so he could gas in his car?
With hindsight, the Blue Light Special presented a valuable lesson on crowd psycholgoy. Many people bought what ever I was selling because they feared they would be missing out on a good deal if they didn't. The gathering of a crowd ensured that many consumers simply lost their minds.
The same thing can happen in the stock market. Stocks that are going up tend to bring in new buyers who don't want to miss out on the next big thing. It is the law of upticks - upticks bring more upticks.
Eventually, investors realize that the stock's price has gone up too much, that the madness of the crowd caused the market's pricing mechanism to make a mistake. Like the shopper who hopes to return an ugly porcelain figurine that looked so much better cast in a pulsing blue light, the investor sells the hot stock in a panic.
This causes a quick pull back in prices after a euphoric run higher. I have created a Market Scan for our members called Bursting Bubbles, which seeks stocks that are likely to sell of quickly, and are worth short selling. This is a swing trading strategy, which means that it has an expected hold period of 1 to 3 days.
Below are two examples of how this strategy has played out this past week. The first stock was IVAN, which gave the sell signal where I have circled. Within a couple days, the stock had moved dramatically lower.
Another example is in T.HBC, which had made a very fast run higher, and then sold off sharply for a few days as the market took profits. The short seller could benefit from this volatility.
Finally, I have provided a stock that meets the requirements of this strategy, and was found using the Bursting Bubbls Market Scan on Friday. FARO has come up very fast, but has now given the signal that it is likely to go lower over the next few days.Back To Top
1. IVAN
IVAN gave the sell signal where I have circled. Within a couple days, the stock had moved dramatically lower.
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2. T.HBC
Three days ago, T.HBC gave a short sell signal using the Bursting Bubble strategy. You can see how quickly the stock sold off over the next couple if days.
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3. FARO
FARO is giving a signal that it is likely to go lower in the short term, after a very impressive run higher over the previous month.
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References
Get the Stockscore on any of over 20,000 North American stocks.
Background on the theories used by Stockscores.
Strategies that can help you find new opportunities.
Scan the market using extensive filter criteria.
Build a portfolio of stocks and view a slide show of their charts.
See which sectors are leading the market, and their components.
Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
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