Stockscores.com Perspectives
For the week ending March 19, 2004
In this week's issue:
Price volatility is a very important concept when applying technical analysis to stocks, yet it is not given a lot of attention. Understanding what volatility is and how to use it can make a big difference in the success or failure or your investments, whether you are a long term investor or a short term day trader.
Price volatility describes how much a stock moves up or down over time. A penny stock will tend to have much more volatility in price than General Electric since penny stocks can routinely move 10% in a day, while that much of a move in a large cap stock like GE might take an entire month to occur.
What price volatility really indicates is the uncertainty that investors have about a company's future. The reason penny stocks can experience significant price change is because there is a lot of uncertainty about their future as a company. A well established, diversified large company has predictable earnings and revenue, so the price of their stock will not move as much.
What I want to focus on in this discussion of price volatility is not how one stock's volatility compares to another, but instead, how a stock's price volatility compares to its historic volatility. How volatile is the stock relative to its normal trading activity?
This is an important question because our success as investors will improve if we can understand the level of uncertainty that investors in a company feel. Risk is minimized when we purchase stocks that demonstrate a low amount of investor uncertainty. Opportunities arise when we identify stocks that are breaking from periods of low uncertainty.
Here is an example to demonstrate the point. A stock is trading at $10, and has been trading around $10 for the past few weeks. The stock might rise or fall $0.20 in a day, but it is showing a minimal amount of price movement around that $10 range.
The market activity on this stock tells us that investors believe the company is worth about $10. Since there is very little volatility in price around that $10 range, there is a high level of confidence that the stock is worth $10. If investors were not sure what the stock was worth, we would expect it to move up and down much more in price.
One day, the stock jumps to $11, far beyond the normal range that the stock is trading in. Why would this occur? If investors believe that the stock is worth $10 (give or take $0.20), what would cause some investors to pay $11? The answer is probably that there is new information to justify the increased price. The company may have made significant fundamental changes, or the market may have become aware of new information that justifies a higher price.
Stocks that break from periods of low volatilty tend to move in to trends, as the new information causes other investors to jump in to the stock. This is why an understanding of price volatility is so important. Volatility is uncertainty, the more volatile a stock is, the more uncertain the market is about what the company is worth. Low volatilty indicates confidence, and we should take a close look at stocks that break from confidence.Back To Top
A top down approach to analyzing the market requires that we first look at the general market indexes to get a flavor for where stocks are heading. When I look at the Nasdaq, Dow and the TSX, I see a Sentiment Stockscore falling and either at 60 or below 60. That tells me that investors are pessimistic, and stocks in general are more likely to go down than up. That does not mean that some stocks can't go up, but it is easier to paddle with the current than against it, and right now it looks like pessimists are steering the canoe.
With that in mind, I again look for short sell candidates, this week using the Long Term Breakdowns market scan. It produced many candidates, of which two stand out as likely to head lower.Back To Top
1. KLAC
KLAC has been falling for some time, but stalled for the past couple of weeks at support. Friday brought a breakdown through important support at $52, making KLAC a stock that is likely to fall some more.
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2. ROP
This stock recently broke down from a head and shoulder topping pattern, and after stalling under resistance, looks like it is ready to go lower again. This is a relatively slow moving stock which makes it a conservative short, unless the trader leverages with options. Resistance is at about $49.
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References
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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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