Is volatility rocking your trading game or does it make you excited? Just what is volatility and how can you put it to your advantage? High volatility is associated with uncertainty and risk. And when it’s high, there’s potential for big price swings. I embrace high volatility for the stocks I trade … and I can teach you to do the same.
Market volatility — it’s one of those stock market terms that can strike fear in the hearts of some traders. For others, it brings feelings of anticipation and excitement.
It’s discussed by the talking heads on financial news channels. It’s cursed by investors who fail to see it coming. And it’s written about in academic papers.
If you’ve been following the markets this year, you’ve heard the term volatility a lot. Get used to it …
A recent CNBC article called 2018 the most volatile year on record. (Check out that video — the Credit Suisse strategist predicts that market volatility will continue.)
What do I think? I’m not making any grand predictions, but I’ll say this:
I embrace high volatility for the stocks I trade.
And I teach my Trading Challenge students to do the same. But it can be unnerving if you’re a newbie.
Recently the market has had a fair number of volatility spikes, so here’s a primer to help you keep your cool when things get rocky.
Table of Contents
- 1 What Is Market Volatility?
- 2 How to Calculate Volatility of a Stock
- 3 Key Trading Tips for Volatile Markets
- 3.1 1. Try to Identify the Reason for the Market Volatility
- 3.2 2. Acknowledge That the Market Has Shifted
- 3.3 3. Evaluate Other Potential Opportunities
- 3.4 4. Refocus on Your Education
- 3.5 5. Look at Who Is Making Money
- 3.6 6. Remember: Panic Is Not a Strategy
- 3.7 7. Consult With Your Mentor
- 3.8 8. Don’t Give Up
- 4 The Bottom Line
What Is Market Volatility?
To understand market volatility and how it can work for you as a trader, first you need a basic definition:
Volatility is a statistical measure of the gap between low and high prices of a stock.
In other words, it’s a measurement that accounts for the stock’s price range — usually over time and in relation to current price.
For overall market volatility, you make a similar calculation using one of the major stock indexes, like the S&P 500.
I’ll give you a formula to calculate volatility later in this post.
How Are Volatility and Risk Related in an Investment?
According to Investopedia, “volatility refers to the amount of uncertainty or risk related to the size of changes in a security’s value.”
In layman’s terms, that means volatility increases when there’s uncertainty — that brings a risk of bigger price movements.
I like that.
Financial experts often refer to the VIX, a market volatility index.
Created by the Chicago Board of Options Exchange, it uses call and put options to measure future bets on individual stocks and the market as a whole.
While that sounds complex, think of it as a way to forecast market volatility.
What Does High Volatility Mean?
High volatility means the range between upper and lower prices is high …
When buyers outnumber sellers, high volatility sends the stock price higher.
When there are more sellers, high volatility sends the price of the stock lower.
Both moves are examples of supply and demand combined with high volatility.
Benefits of Trading in High-Volatility Markets
I love trading high-volatility penny stocks. My trading strategies depend on high volatility.
What is volatility trading?
It’s planning your setups based around high volatility. While volatility isn’t the only factor, without it the percentage or price movements aren’t big enough to interest me.
Big movements in volatile markets mean I don’t have to get in and out at the very bottom or top of the price move for the trade to be successful …
I can wait for confirmation (although sometimes it’s not much of a wait!) before I get in.
Because I tend to trade conservatively, I get out when the trade hits the exit point outlined in my trading plan.
At the very least — I close out enough of my position to protect profits and let the rest ride.
How to Calculate Volatility of a Stock
There’s more than one volatility calculation out there — meaning it can be a little subjective. The classic measure is called standard deviation.
Because I’m interested in volatility as it relates to price swings, I’m going to show you how to calculate volatility a different way first.
I’ll use the average true range (ATR) method.
(Pro tip: Add an ATR indicator on most stock charting tools — so you won’t need to do these calculations yourself.)
- Calculate the true range (TR) for one period. The TR is the difference between the high and the low.Here’s a simple example: A stock’s daily high was $10, and the low was $6. The true range is $4. (10﹣6 = 4).The standard number of periods to calculate the ATR is 14, but for simplicity we’ll use only three.
- Let’s assume the three daily TRs are $4, $3, and $4.25. Now find the ATR: (4 + 3 + 4.25) ÷ 3 = 3.75.
- Next, use the ATR to calculate volatility as a percentage of price.Say the stock’s current price is $14. Divide the ATR by the current price and state it as a percentage: 3.75 ÷ 14 = .27 or 27% volatility. (This is super high volatility! You won’t find many blue chip stocks even close to this.)
Market Volatility Formula
This is one of those times I’m going to tell you to do your homework and point you in the right direction.
That’s because I could write five posts just on different types of volatility. Seriously!
However, I will give you the standard deviation formula so you can see how it works:
Imagine you have three closing prices of $12, $14, and $16.
- Find the average: (12 + 14 + 16) ÷ 3 = 14
- Calculate the deviation by subtracting the average value from each day’s close:
12﹣14 = -2, 14 － 14 = 0, and 16﹣14 = 2. You get ﹣2, 0, and 2.
- Square the deviations and you get 4, 0, and 4.
- Add the squared deviations: 4 + 0 + 4 = 8
- Divide by the number of data values (three trading days in this example): 8 ÷ 3 = 2.66.
- Find the square root of the variance: The square root of 2.66 = 1.63 … that’s the standard deviation.
Standard deviation is used by many institutional investors to calculate volatility and risk. It gives traders an idea of how far prices might swing from the average.
Market Volatility Examples
Are you ready for my daily mantra? Keep studying. Study hard. Build your knowledge.
For a good example of market volatility right now, look no further than the DJIA. Check out the chart below for the last three months. The two circled candlesticks in October represent two super high market volatility days.
The result? Look at the chart: The DJIA dropped 1400 points in those two days.
While I trade penny stocks and this chart represents big companies, it’s a good example of market volatility.
Volatility in the overall market can affect other markets — so pay attention!
Key Trading Tips for Volatile Markets
1. Try to Identify the Reason for the Market Volatility
When you see an increase in market volatility, it’s a good idea to try to understand the reason.
The cool thing is that, as with individual stocks, it’s usually something you can identify.
For example: News can drive volatility. Think big world news events. Over in the UK, the Financial Times Stock Exchange (FTSE) went through a period of high volatility when the Brexit deal was announced.
Other times, the reason might not seem so obvious …
It might be the storm following a long period of calm or steady movement in one direction. If you look at the VIX chart for the second half of 2018, you’ll see a massive spike in volatility in October — right after a long period of relative calm.
The spike perfectly matches that 1400 point drop in the chart above.
Some traders call the calm period a listless or stagnant market. Eventually, volatility becomes necessary to get things moving again.
2. Acknowledge That the Market Has Shifted
Sometimes we all need a little wake-up call. Markets change — and when they do you have to change with them.
Otherwise you can get pummeled.
One of my first big trading lessons happened in the spring of 2000, when the easy money of the dot-com boom came to a screeching halt.
The Nasdaq tumbled along with all those cash-eating, no-revenue companies. Suddenly, the patterns I used to go from a small account to well over six figures were not available.
Volatility was through the roof at the time, as panic followed panic.
It was enough to put a little fear in me, so I sat on the sidelines for a while and watched things unfold. I’ve always been conservative that way.
I wasn’t aware at the time how good my instinct was. I was itching to trade — and it forced me to start looking for new plays.
3. Evaluate Other Potential Opportunities
When things seem out of control, take a step back and look at the big picture. Then start looking for other opportunities.
It’s the classic ‘one door closes and another opens’ scenario. The stock market can imitate life in that respect.
Back when I was forced to look for new plays, I discovered short-selling. Now it’s one of my favorite strategies.
In case you don’t know, short-selling means you borrow shares to sell and then buy shares at a lower price to pay back those you borrowed. In other words, it’s a bet for the stock price going down.
When you join the Trading Challenge and put in the effort, you can learn to wisely make money whether the market’s up or down. You’ll even embrace volatility…
4. Refocus on Your Education
When things get a little rough — and I know the market behaves erratically at times — the best thing to do is take a step back and dig into your education again.
Trading is a lifelong skill. It takes time and massive effort to master. Once you’ve been through a few up and down markets and high-volatility periods, you’ll have a better idea how to respond.
For now, understand that you should be studying all the time.
When in doubt, say during a high volatility period, study more. Consider it your chance to witness firsthand what kinds of price swings can happen.
I’d also recommend paper trading during this time. Prepare yourself for next time — because high-volatility markets seem to come and go.
5. Look at Who Is Making Money
I think this is a very underrated and overlooked concept …
What would you do if you wanted to be really good at something? Would you go hang out with someone who was bad at it? Would you listen to the advice of someone who sucked?
Unless you want to fail — no. You wouldn’t. You’d seek out the best. You’d figure out what they did to get where they are.
Trading is the same. Find the traders making money — like my ace students.
Figure out where they hang out, like the Trading Challenge chat room, and hang out there. Pay attention to what they’re doing. Ask them questions.
Learn the mechanics of how they’re trading.
They’re totally up front about both wins and losses. That’s something you should take advantage of. There are a lot of so-called guru traders who are full of crap and don’t share all their trades with you.
Model success. It’s the fastest way to get there yourself!
6. Remember: Panic Is Not a Strategy
I’ll go one step further with this one and say…
… Some traders panic. Don’t be like them.
As you get better, you’ll start to recognize this more and more.
Go one step further: Have a strategy in place for when others do panic. Understanding this can make the difference between the 90% who lose and the 10% who win.
What’s the easiest way to avoid panic? Have a plan. Practice the plan: Go over it mentally several times.
Paper trade your plan until it’s second nature. Then, when you trade the plan with real money, you’ll know exactly what to do when things go wrong (it happens to every trader at some time).
Heck, I only win 74% of the time. I know very profitable traders who only win a little over 50% of the time. The key: They don’t panic. They trade their plan.
So make a plan and stick to it. If things go wrong, cut your losses quickly and learn from the trade.
7. Consult With Your Mentor
This is huge.
Trading can be a very lonely profession. When the market seems to be going mad and you’re trying to figure out what to do, your mentor can be an excellent sounding board.
Too many traders lock themselves away researching, watching stocks, watching the markets.
The benefit of networking with other traders — especially your mentor — can’t be over emphasized. If your mentor has been around a while (I have 20 years in the trenches and 10 years teaching) they’ve probably been through periods of high volatility.
Take advantage of this knowledge.
To be perfectly clear: I’ve been there and done that in almost every type of market. It’s one of the reasons I decided to start teaching.
My goal is to help traders go from newbie to self-sufficient trader in the shortest time possible.
You gotta study your ass off to do it. But, oh yeah, it’s worth it.
8. Don’t Give Up
I have story after story of students who wanted to quit at one time or another but stuck it out. Now they’re crushing it.
It’s all about gaining experience and learning from mistakes. And never giving up.
Do you know how many people quit just when they’re so close to putting it all together? Ever known someone to do this?
I like to use the example of a baby learning to walk to explain this …
Imagine what the world would be like if parents said to their toddler, after the 50th time they fall, “Better give up. You’ll never walk.”
That would be absolute bullshit, right? So why do so many adults give up?
After spending so much time preparing, they give up when they experience failure. What a waste!
The best traders learn from their failures. For that matter, the best in almost any field seem to be those who experienced a lot of failure but didn’t give up.
Do you know Thomas Edison’s story?
It’s said that Edison failed 1,000 times in his attempt to create a light bulb. When a reporter asked him what it was like to fail that many times, his reply was simple: “I did not fail 1,000 times. The light bulb is an invention with 1,000 steps.”
Remember that as you work to become a successful, self-sufficient trader. Don’t let the market volatility get to you. Embrace it.
The Bottom Line
Market volatility can be the penny stock day trader’s friend.
Now that you’ve read this primer, it’s time for you to go do some research …
Learn as much as you can about volatility and how it applies to trading. See how it fits with the chart patterns you’re studying.
And if you aren’t already paper trading, start now. Use what you’ve learned here to learn more.
Write down questions as they come up. See if you can find the answers in other blog posts or on my YouTube channel. Go through the Trader Checklist and Penny Stock 101 information here on the website.
I talk a lot about high volatility and how it applies to my strategy.
When you’re ready, apply for the Trading Challenge. It’s the course for those who want to master trading and make it a profession — one that can potentially provide an amazing lifestyle.
Are you a trader? How are you dealing with market volatility in your trading? Let me know in the comments. I love to hear from you!