Price Volatility
Stockscores.com Perspectives for the week ending January 15, 2005
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In this week's issue:
Price volatility is a very important concept in technical analysis, yet it is often overlooked or misunderstood. While many technical analysts get lost in the details of complex indicators, change in price volatility is providing a valuable message on the direction that a stock is likely to go.
The change in price over a period of time defines price volatility. This time period can be over two minutes or over a year. What is important is how current price volatility relates to the past. When we describe a stock or market as having low price volatility, it is really relative to its own history and not other stocks. What is highly volatile for one stock may be low for another.
The volatility of price is important because it tells us a lot about the uncertainty of investors. The more unsure the market is about what a company is worth, the more volatile its stock price will be. That is why speculative stocks tend to be much more volatile than blue chip stocks. Their future business prospects are less certain, and so, their stock prices change more over time.
If price volatility diminishes over time, then we can argue that investors are gaining greater confidence in what the company is worth over time. Market participants are coming to some consensus on what the company's fundamentals are worth and the price action is settling down.
This process of price consolidation is important because it often leads to significant price trends as the market breaks from the period of confidence. If we assume that low price volatility is the result of the market agreeing about what the company's fundamentals are worth, then breakouts from periods of low price volatility may be caused by significant changes in company fundamentals.
What I have found is that stocks that break from periods of price consolidation often do so shortly before the announcement of important news. Experienced traders know that the market tends to move in anticipation of news, making breaks from low price volatility an important clue that news is coming.
As a trader, almost all of my trades come from abnormal breaks from low price volatility. I will short sell stocks when they break down through support from low volatility and I will buy stocks that break out through resistance from low price volatility. If you consider all well known chart patterns (ascending and descending triangles, head and shoulders, cup and handles, pennants etc.), you will find that breaks from low price volatility are a common theme.
It is therefore important to gain an understanding of price volatility and learn to look for it on a stock chart. By adding this simple visual indicator to your tool box of analytical methods, you can improve your trading potential.
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Stocks go up in price because investors are willing to pay more. Investors tend to buy companies that they are optimistic about, so it is important to measure whether investors are generally optimistic or pessimistic about a company. Stock charts can provide many clues about the mood of the market. For example, rising bottoms on a stock chart indicate greater enthusiasm among buyers than sellers.
The Sentiment Stockscore considers these kinds of chart pattern factors, and provides an indication of whether investors are showing optimism or pessimism. I have found that stocks that have a Sentiment Stockscore moving through 60 and rising tend to continue to rise as investor optimism carries them along.
The Sentiment Crossover Market Scan seeks stocks that have their Sentiment Stockscore crossing in to the 60 and greater zone after a lengthy period below 60. If this occurs, and the stock does not have significant overhead resistance, then there is a good potential for a future uptrend. By limiting downside potential with a stop loss point just below a short term support price, investors can better manage risk while leaving the potential for price gains.
This strategy is good for identifying longer term trades that do not require constant monitoring. The criteria are relatively simple, and a regular check of positions for an exit signal may only take a few minutes.
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1. T.DMX
After bouncing off support at $0.30, T. DMX has started to show life again with rising bottoms, a sign of optimism. While there is lots of resistance to work against, it looks like investors have not given up on this stock yet.
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2. NASI
NASI's downtrend was broken about two weeks ago, and the stock has been consolidating with an optimistic rising bottom since. Ideally, the stock will make a break through short term resistance at $5.75 and reverse the downtrend.
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3. CGPI
Abnormal activity on CGPI before Christmas was an indication that investors were getting optimistic about something with this stock after a lengthy downward trend. The stock has been consolidating nicely under resistance at $7.50, a break through the price point would be important.
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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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