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.