They say volatility creates opportunities in trading top penny stocks. For those not familiar, volatility is something that is attempted to be measured, the most generally accepted method of measurement is the standard deviation. The standard deviation is expressed in annualized % terms, and tell us how much prices deviate from the mean.
In other words, standard deviation is a statistic that measures the amount of variability around the mean.
Let’s say the price of a stock is trading at $10, and has a historical volatility of 30%. As mentioned earlier, standard deviation is measured in annualized terms. We would take the stock price and multiply it by 0.30, which gives us the number 3.
A one standard deviation move encompasses about 68% of the normal distribution. In this example it means that there will be a 68% chance that the stock price will be within $7 to $13 on the year. On the other hand when trading top penny stocks, to get a two standard deviation, we simply multiply our first figure by two. In this example it’s 6.
According to our historical volatility, there is a 95% chance the stock price will be trading within $4 and $16 on the year.
Now, we mentioned that historical volatility is expressed in annualized terms. However, you can convert that into a daily volatility if you wished when trading top penny stocks. In order to translate the annualized volatility, take the number of trading days in the year and square root them. Generally there are around 252 trading days in the year, when you square root that, you get 15.87.
So, if we have an annualized volatility of 30% we take that number and divide it by 15.87. In return, we get a number of 1.89%. That means on average we can expect it move within a +/- 1.89% on any given day.
In general, volatility is mean reverting. Periods of high volatility are usually followed by periods of lower volatility, and vice versa. Traders can use this information to size their top penny stocks trades better.
For example, let’s assume volatility has expanded. If you’re aware of that, you might want to trade smaller to compensate for the wilder swings. In addition, under higher volatility, you can make or lose with less shares because the price swings are greater.
In most cases, volatility expands when stocks experience downward pressure. The move towards the downside is usually quicker, when compared to when stock prices rise. When stock prices rise, they tend to grind up.
With that said, you can use volatility to gauge fear and greed in the market when trading top penny stocks. The most commonly used metric for the overall market is VIX. The VIX more or less tells us about the volatility in the S&P 500 index. A low VIX means there is little fear in the market, a higher VIX means there is fear.
In summary, knowing the volatility of a stock can help in your position sizing. You might be able to use those numbers to gauge sentiment in the stock as well. For a bigger picture perspective, the VIX can be used to measure gauge fear and greed in the overall market when trading top penny stocks.
We live in a world where algorithmic trading dominate the daily volume seen in the stock market today. With that said, there are a ton of news reading algos that react to headlines instantaneously, causing tremendous volatility in the company’s referenced in the stories, especially hot penny stocks.
Some traders who rely on technical indicators to make decisions will totally dismiss news all together. Their belief is that the news is already priced into the stock and the price action will dictate where it will go. They feel it’s extremely difficult to quantify the impact of the news so it’s more or less a waste of time to follow it.
Does this philosophy make sense, and how important should following the news be when trading hot penny stocks?
Let’s say the stock price of company ABC has had support at $15, if it were to drop to that level, a trader relying solely on technical analysis will buy some shares. The stock price drops from $17 down to $15, the trader goes long, and the stock quickly drops another $3. It turns out that a news story broke out that ABC is under investigation for accounting fraud and that the CEO has left the country.
Here is a situation where there is a dynamic change in the company’s fundamentals. If you’re an investor, you’re thinking worst case scenario, you’re not necessarily thinking about support and resistance levels. You’re mind is thinking, get out, and ask questions later.
Clearly, in a situation like this, knowing the news can be very helpful when trading hot penny stocks.
Let’s say you trade style utilizes a mean reversion strategy, and company ABC is down $6 and on average it trades in a range of $2. Again, not knowing the news, you might decide to buy some shares. However, if you paid attention to the news, you would have known they just announced their earnings and that additional volatility is not unusual.
This is another example where the news helps in making better trading decisions.
Now, you don’t have to try to quantify everything to make knowing the news useful. For example, let’s say a well known analyst upgrades company ABC and their stock price gaps up on the open. What is the upgrade worth? It’s really hard to say, clearly a positive sign, but hard to measure the impact.
Does that mean having that information is useless? Absolutely not – especially with penny stocks.
It’s when you try to overanalyze the news, in this case, it can causes problems in your trading. For example, let’s say Company ABC has announced that are expanding their business to more regions, this might be seen as a positive news. However, it might not be reflected in their stock price right away.
Letting your opinion get in the way can also be an issue. For example, this is good news, the stock price should be going up…or this is really bad news, the hot penny stock price should be crashing.
With that said, it’s still better to be aware of the headlines and what is going on in the stock you’re trading. Sure, it’s very difficult to trade off the news, and not what is being suggested here. But including the news in your decision making process is a choice many traders make and they fare better when trading hot penny stocks.