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A common mistake of novice traders is to focus on the wrong securities or markets. While every trader should develop his or her own personal style, success will elude them, no matter how talented they are, without one key ingredient: volatility.
Unlike long-term investors, successful traders thrive off of volatility, or rapid changes in the price of the securities they are trading. If you focus on a stodgy blue chip stock that only ever moves 10% up and down per year, you will have to be a razor sharp trader to make enough profits for the venture to be worthwhile. You’ll also be competing with traders who almost certainly have better technology set-ups, faster bandwidth and better information than you (do you pay for a Bloomberg terminal? Didn’t think so).
A better approach is to take a top-down view of the areas of the market experiencing volatility and then develop a strategy for trading off of it. When you focus on a naturally volatile sector of the market, every day provides potentially solid opportunities for you to make (or lose) money. Remember, a trader needs moves both up and down to make a market tradable. For a trader there is nothing worse than a flat market.
This is why we previously recommended penny stocks as a great starting place for new traders. The entry points are modest, but the moves up and down are major. Just this past week we witnessed more than five stocks make daily moves of 100% of more—one stock, SPI, jumped from just over $1.00 per share to more than $40 in the same trading session. This is the type of volatility that expert traders live for.
However, penny stocks are far from the only game in town and some of you may be rightfully turned off by that corner of the market known for fraud, toxic financing and constant misplaced hype from bagholders on Stocktwits, Seeking Alpha and Reddit.
Below we list some other sectors and individual stocks that are experiencing consistent volatility and attracting all types of traders. One you have settled on a volatile sector or group of stocks, then the real work begins of studying, researching and developing an edge through technical analysis and/or a detailed point-of-view of fundamentals. Ideally this edge is based off of a statistically significant backtest.
For this type of work we recommend the excellent tool TrendSpider. We also like Barchart for its combination of fundamental research and technical analysis tools.
Please note any stocks mentioned below are merely examples and are NOT recommendations. You should do your own research and be sure to develop an edge based on statistical probabilities before attempting any trades.
Bankruptcy Rumors
Despite how crazy it seems, stocks that are on the verge or have even announced bankruptcy can make for extremely volatile and therefore attractive targets for short-term traders. Just this year we have seen huge moves in stocks such as Hertz, JC Penney and Frontier Communications, even after the fate of these companies as going concerns seemed settled.
There seems to be two main reasons that stocks on the verge of bankruptcy gyrate in their last months and days on the market. One is related to last-minute rumors, often related to potential buyouts or financing deals that can prolong the life of the company or even temporarily change its trajectory. More often, however, the volatility of these stocks has to do with short-covering, when long-time bearish investors who have been betting against the stock decide to close their positions and declare victory. The mechanics of short-covering often mean a temporary bump up in the price.
Many publications have theorized that the newfound popularity of day trading in 2020 since the coronavirus pandemic took hold has given zombie stocks like this another life, so that when a bankrupt company’s shares experience a temporary boost from a short cover, novice investors latch on to the positive momentum without entirely knowing why. It’s certainly possible in this crazy year.
Bad Headlines
Another similar volatility producer is when a company experiences seriously bad headlines, often as a result of a short-selling firm’s bearish research report.
Luckin’ Coffee, Nikola and Kodak have all experienced negative headlines this year, and as a result have experienced serious volatility as many rush in to join the bears, while others poke holes in those reports and see a buying opportunity.
It’s obviously risky to get involved in stocks experiencing prolonged negative headlines as short interest rises and the threat of delisting becomes more likely, as happened with Luckin’ Coffee, which now trades OTC (and remains volatile) as LKNCY. Nikola has had multiple recent days of double digit percent losses, while Kodak’s price has swung on both positive and negative rumors, many of which have yet to materialize.
Growth and “Story” Stocks
On the more positive side, stocks that have a lot of positive momentum and a fan base of true believers can also provide volatility, particularly around their earnings reports. Stocks like Tesla and Virgin Galactic have produced enormous gains over a 12 month period but are also prone to vicious short-term reversals on any fleeting negative headlines or suggestions of disappointment in their growth tracks.
Tesla’s somewhat underwhelming “Battery Day” is just one example of such an opportunity for short-term traders to analyze and potentially profit from.
Fallen Angels
Just as “story” stocks provide opportunities, so too do once might names that have been cut down to size. There is no coincidence that General Electric (GE), a former Blue Chip titan now trading for just $6 per share remains one of the most liquid options plays. When reviewing current analyst opinions you can find a clear divide between those betting on the company’s continued struggles (and decline) and those favoring an epic comeback on the basis of the turnaround work of CEO Larry Culp.
While it’s possible GE stays in the doldrums and the stock doesn’t move much, traders see the possibility for a big move up or down and this type of binary outcome is what attraction options traders and other to the stock—it’s certainly not the $0.01 quarterly dividend, LOL.
To see how much a fallen angel stock can move off its lows just check out Diebold (DBD), the once high-flying German leader in ATM manufacturing for banks across the world. After taking on too much debt the stock plummeted from more than $37 per share to a low of $2.50 in December 2018. From that sickening low, the stock made a move over the course of the next seven months all the way back to a high of $14.20 on signs that new management’s strategy was working.
That type of turnaround bounce back is manna from Wall Street heaven for traders and would have led to a gain of more than 560% in about a half year…not too bad for a supposedly has-been company.
Could we see a similar move eventually for GE?
Hot Sectors
While trading individual stocks can be worthwhile, even highly liquid and hyped stocks can have quiet periods. It’s often better to think about sectors, which also give you the option of trading on a more macro-level through ETFs.
It seems every year there is a new “hot” sector. In 2017-2018 it was blockchain, in 2018 cannabis, and now in 2020 the market has greatly rewarded both vaccine stocks and the “stay-at-home” stocks such as Zoom, Netflix and Peloton.
The trading theme here is less about individual names and more about how the overall market trend will (or will not) continue. Big technology names have been consistent leaders this year, but increasingly seem to be in a push and pull with more cyclical sectors that were absolutely crushed during the lockdowns.
Developing a point-of-view on this continued tussle between the market leaders vs. The laggards could present some interesting long/short trade ideas based on how you see the trend continuing or being disrupted.
Beaten-Down Sectors
Sometimes like a fallen angel stock, an entire sector becomes a fallen angel and with it becomes similarly volatile.
This is exactly what we’ve seen this year in the ETF JETS, which represents a collection of airline stocks. As headlines about a coronavirus vaccine and reopening economies offered hope, this ETF would surge based on improving prospects for more airline travel. As headlines grew cloudier, the airlines ETF would crash.
This pattern of dramatic spikes and crashes can present an opportunity for traders, although they will need a tough stomach to handle any surprising headlines that could impact this ETF or the underlying stocks such as Delta Airlines (DAL), American Airlines (AAL) and Southwest (LUV).
Final Thoughts
If you want to trade, don’t focus on the obscure or quiet. You want high volume, high newsflow and high volatility. The good news is whether it comes to volatile sectors or individual stocks, you can find a way to approach these areas with your own trading style: whether based on technical analysis, fundamentals or a macro approach. Just make sure you have a true edge before risking your hard earned money.
