Volatility can be defined as the dispersion of returns for a given security or market index over a period of time. It is quantified by short-term traders, for instance, as the average difference between a stock's daily high and daily low, divided by the stock price. A stock that moves $5 per day with a $50 share price is thus more volatile than a stock that moves $5 per day with a $150 share price because the percentage move is greater with the first.
Trading the most volatile stocks is an efficient way to trade because, theoretically, these stocks offer the most profit potential. Not without their own dangers, many traders seek out these stocks but face two primary questions: How to find the most volatile stocks, and how to trade them using technical indicators.
Key Takeaways
- Traders often seek out the market's most volatile stocks in order to take advantage of intra-day price action and short-term momentum strategies.
- Several online screener tools can help you identify and narrow down the list of volatile stocks that you wish to trade.
- Volatility, while potentially profitable, is also risky and can lead to larger losses.
How to Find the Most Volatile Stocks
Finding the most volatile stocks is not very complex and no longer requires constant research or stock screening. Instead, you can set up and run an ongoing screener for stocks that are consistently volatile.
StockFetcher is one example of a filter you can use to track very volatile stocks. Applying customizable filters, Stock Fetcher will pick stocks with average moves greater than 5% per day (between the open and close) over the past 100 days.
Volume is also essential when trading volatile stocks, for entering and exiting with ease. You can use this tool to also filter stocks, for example, priced between $10 and $100 and with an average daily volume of over 4 million in the past 30 days. Furthermore, if you are only interested in stocks and not exchange-traded products, adding a filter like "exchange is not Amex" helps avoid leveraged ETFs that might otherwise appear in the search results.
A more research-intensive option is to manually look for volatile stocks each day. Finviz.com offers a free version that provides top gainers, top losers, and the most volatile stocks for each trading day. Use the screener tool to further filter results for market capitalization, performance, and volume. Narrowing the search in this fashion provides traders with a list of stocks matching their exact specifications.
Nasdaq also lists the biggest gainers and losers on the NASDAQ, NYSE, and AMEX exchanges. These are not filtered results and only reflect volatility for that day. Therefore, the list provides potential stocks that could continue to be volatile, but traders need to go through the results individually and see which stocks have a history of volatility and have enough volume to warrant trading.
Trading the Most Volatile Stocks
Volatile stocks are prone to sharp moves, which requires patience when waiting for entries but quick action when those entries do appear. Certain indicators can be used to trade volatile stocks, but the trader must also monitor price action—watching if the price is making higher swing highs or lower swing lows, relative to prior waves—to determine when indicator signals are taken and when they are left alone.
Below are just two technical indicators you can use to trade volatile stocks, along with what to look for in regards to price action.
Keltner Channels
Keltner channels put an upper, middle, and lower band around the price action on a stock chart. The indicator is most useful in strongly trending markets when the price is making higher highs and higher lows for an uptrend, or lower highs and lower lows for a downtrend.
During a strong uptrend, the price will "ride" the upper Keltner channel, and pullbacks will often barely reach the middle band and not exceed the lower band. The mid-band is thus a potential entry point. A stop order should be placed roughly one-half to two-thirds of the way between the mid-band and the lower band. An exit is placed just above the upper band.
Apply the same concept to downtrends. The price often tracks the lower Keltner channel line, and pullbacks will often reach the middle band but not exceed the upper Keltner line. The middle line thus provides a short-entry area—a stop is placed just inside the upper Keltner line and a target is below the lower Keltner line.
On most charting platforms, the default measures for Keltner channels are typically set to use the previous 20 price bars and use an Average True Range (ATR) Multiplier of 2x. The reward relative to risk is usually 1.5x or 2x, meaning for $1 of risk the profit potential is $1.50 to $2.00.
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Since Keltner channels move as the price moves, the target is placed at the time of the trade and kept there.
One advantage of this strategy is that an order is waiting at the middle band. Timing the entry is thus not so vague—and once all the orders are placed, the trader does not need to do anything except sit back and wait for either the pre-set stop or target order to be filled.
For more hands-on traders, the strategy can be more actively managed. During a very strong trend, the target can be adjusted to capture more profit. The stop and risk levels should only be reduced as the trade becomes profitable; risk is never increased during a trade.
A disadvantage of this strategy is that it works well in trending markets, but as soon as the trend disappears, losing trades will commence since the price is more likely to move back and forth between the upper and lower channel lines.
Filtering trades based on the strength of the trend helps in this regard. For example, during an uptrend, if the price failed to make a higher high just before a long entry, avoid the trade, as a deeper pullback is likely to stop out the trade.
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Bollinger Bands
Another technical analysis indicator that can assist in trading volatile stocks is the Bollinger Bands. These bands are used to measure volatility and identify potential overbought or oversold conditions in a stock's price. The bands comprise of a middle band and two outer bands that are typically two (2) standard deviations away from a simple moving average (SMA) of the security's price, although the number of deviations can be adjusted according to your preference.
Bollinger Bands are particularly effective in trading volatile stocks because they adapt to changes in volatility and can provide insightful signals about potential price movements. One instance entails trend identification. When the bands are wide apart, it indicates high volatility. This could signify strong trend movements. Conversely, narrow bands suggest low volatility and can often precede sudden price movements as the stocks breaks out of a consolidation phase.
Another instance of using Bollinger Bands to trade volatile stocks is through the "squeeze". This occurs when the bands come very close together, indicating that the stock is trading in a tight range (low volatility). This is often followed by a significant price movement. Traders watch for a squeeze and then a subsequent breakout above or below the bands to signal entry points.
Moreover in highly volatile environments, stocks may extend beyond the Bollinger Bands but eventually revert to the mean (middle band). You can look for situations where the price significantly deviates from the middle band and then enter positions betting on a reversion to the mean.
Indeed, Bollinger Bands offer significant advantages for trading volatile stocks due to their ability to adapt to changes in volatility and provide clear trading signals, traders must be aware of their limitations and ideally use them in conjunction with other analytical tools to improve accuracy and effectiveness.
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Stochastic Oscillator
The stochastic oscillator is another indicator that is useful for trading the most volatile stocks. This strategy works best on range-bound stocks or stocks that lack a well-defined trend. Volatile stocks often settle into a range before deciding which direction to trend next. Since a strong move can create a large negative position quickly, waiting for some confirmation of a reversal is prudent. The stochastic oscillator provides this confirmation.
When the price lacks clear direction and is moving predominantly sideways, sell near the top of the range once the stochastic moves above a level of 80 and then drops back below. Place a stop order just above the high that just formed with a target at 75% of the way down the range. For example, if the range shows a $10 high (from low to high) place a target $2.50 above the low.
Similarly, take long positions near the bottom of the range when the stochastic drops below 20 and then rallies above it. Place a stop below the recent low and target 75% up the range. If the range is a $10 high the target is placed $2.50 below the high.
Trades should be taken as soon as the price crosses the stochastic trigger level (i.e., 80 or 20). Do not wait for the price bar to complete; by the time a 1-minute, 2-minute, or 5-minute bar completes, the price could run too far toward the target to make the trade worthwhile. Also, ignore contrary signals while in a trade; allow the target or stop to get hit. Once the target is hit, if the stock continues to range, a signal in the opposite direction will develop shortly after. Figure 3 shows a short trade, followed immediately by a long trade, followed by another short trade.
The stochastic oscillator uses standard settings of 12 periods and the %K set at 3.
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In the figure above, the range is $0.16 in height ($16 minus $15.84), so 25% of $0.16 would be $0.04. Therefore, deduct $0.04 from the high of its range at $16 to get a target for long positions of $15.96. Similarly, add $0.04 to the low of the range at $15.84 to get a target for short positions at $15.88. While the range is in effect, these are your targets for long and short positions. This way, the target is more likely to get hit even if the price doesn't make it all the way back to the top or bottom of the range when long or short, respectively.
Consider again the figure above. For the first short trade, just after 1:30 PM, the stochastic rises above 80 and then drops below it. This signals a short trade. Sell at the current price as soon as the indicator crosses below 80 from above. Immediately place a stop above the recent price high that just formed. Set your exit target at $15.88. Do nothing else until either the stop or target is reached. The target is hit less than an hour later, getting you out of the trade with a profit.
The stochastic has since dropped below 20, so as soon as it rallies back above 20, enter a long trade at the current price. Quickly place a stop below the price low that just formed and place a target to exit at $15.96. This trade lasts for about 15 minutes before reaching the target for a profitable trade. Another short trade develops immediately after the prior trade; enter short at the current price as the stochastic crosses below 80, place a stop above the recent price high and place a target to exit at $15.88. The target is reached less than 30 minutes later.
The usefulness of this strategy is that it helps us wait for the price to reach a favorable level, one that is presumably undervalued, even if only temporarily. We can then watch to see if the price will begin to rise from this favorable price level and move in our preferred trade direction before we enter the trade. Therefore, a relatively tight stop can be used, and the reward to risk ratio will typically be 1.5:1 or greater. The main disadvantage is false signals. False signals are when the indicator crosses the 80 line (for shorts) or 20 line (for longs), potentially resulting in losing trades before the profitable move develops.
Since the stochastic moves slower than price, the indicator may also provide a signal too late. When the entry signals occur, the price may have already moved significantly toward the target, thus reducing the profit potential and possibly making the trade not worth taking. Upon entry, the reward should be at least 1.5 times greater than the risk, based on the target and stop.
Example of Trading a Volatile Stock
At the time of writing, GameStop(GME) stood out as one of the most popular and volatile stocks in the US market. To navigate its fluctuations, you could examine trading strategies that incorporate Keltner Channels, Bollinger Bands, and the Stochastic Oscillator.
Keltner Channels Example
A Keltner Channel trading strategy was backtested over the past year. This strategy involved initiating a long position when the closing price surpasses the lower Keltner Channel and entering a short position when it falls below the upper Keltner Channel. Long positions are closed under three (3) conditions: when the closing price drops below the lower Keltner Channel, when it falls below the middle channel, or when it exceeds the upper channel. Conversely, short positions are exited when the closing price rises above the upper or middle channels or falls below the lower channel.
The strategy parameters included a 25-period Keltner Channel with a multiplier of 3.25 The channels utilize an Exponential Moving Average (EMA) and the Average True Range (ATR) over a 10-period span. The simulation began with an initial capital of $1 million, with each trade representing 100% of the account account balance. Taxes, spreads and commissions were not considered. The chart timeframe was set at 10 minutes. The results from this backtest included:
- Total Closed Trades: 202
- Percentage of Profitable Trades: 46.53%
- Profit Factor: 1.067
- Maximum Drawdown: 38.51%
These findings provide insights into the strategy's performance under the tested conditions, highlighting both its profitability and risk levels.
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Bollinger Bands Example
A Bollinger Bands (BB) trading strategy involves initiating a buy when the stock price moves above the lower BB and entering a short position when it falls below the upper BB. Positions are closed under the following conditions: long positions are exited when the closing price falls below the upper BB, the lower BB, or the middle band. Conversely, short positions are closed when the closing price rises above any of these three (3) bands.
This strategy was backtested using a 125-minute candlestick chart for GME from May 2023 to May 2024. The settings for the BB were a 10-period length with a standard deviation set at 2. The simulation began with an initial capital of $1 million, with each trade representing 100% of the account account balance. Taxes, spreads and commissions were not considered. The outcomes of this strategy testing were:
- Total Closed Trades: 441
- Percentage of Profitable Trades: 51.25%
- Profit Factor: 1.366
- Maximum Drawdown: 38.2%
These results offer a preliminary quantitative basis for assessing the effectiveness of this trading strategy under the specified test conditions. Typically, professional traders employ a more comprehensive and rigorous approach to backtesting to ensure robustness and reliability.
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Stochastic Oscillator
Finally, a Stochastic Oscillator trading strategy was backtested over the past year using a 15-minute chart. This strategy involved entering a long position when a positive crossover occurs between the %K and %D lines, with both indicators at oversold levels (below 20). Conversely, a short position is initiated when a negative crossover occurred while both lines are at overbought levels (above 80). It should be noted that initiating a buy signal will automatically close any existing short positions, and vice versa.
The specific parameters used for the Stochastic Oscillator in this backtest included a 10-period %K, a 2-parameter smoothing of %K, and a 3-period of %D. The thresholds for overbought and oversold levels were set at 80 and 20, respectively. The results of this backtesting were as follows:
- Total Closed Trades: 463
- Percentage of Profitable Trades: 36.5%
- Profit Factor: 1.125
- Maximum Drawdown: 33.92%
These results offer valuable insights into the strategy's effectiveness, emphasizing its profitability and risk characteristics under the tested scenarios.
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Do Trend Following Indicators Work on Volatile Stocks?
Trend following indicators can be valuable in trading volatile stocks as they can help in identifying clear trends, provide dynamic support and resistance levels and potentially mitigate risks associated with volatility. However, their success largely depends on your ability to adapt tools and strategies to specific characteristics of volatile markets.
Are there any other Indicators that can be Use on Volatile Stocks?
Trading volatile volatile stocks requires a nuanced approach to technical analysis. Some useful indicators include the Relative Strength Index (RSI), volume indicators such as On-Balance Volume (OBV), Volume Rate of Change (VROC), Volatility Indicators such as Average True Range (ATR) and the Chaikin Volatility indicator. Also there are oscillators such as the Commodity Channel Index (CCI) and the Moving Average Convergence Divergence (MACD).
Each type of indicator has its strengths and weaknesses, and their effectiveness can vary depending on the specific characteristics of the stock and the overall market conditions. Hence using the right combination of these indicators, customized to your style, can significantly improve trading outcomes in volatile stocks.
What are the Risks associated with Trading Volatile Stocks?
Firstly, volatile stocks experience rapid and significant price changes. These swings can result in substantial gains or losses over very short periods, potentially making it difficult for you to execute traders at your desired entry point. Also there is a lot of psychological pressure. The rapid ups and downs of volatile stocks can lead you to make impulsive decisions based on emotions rather than rational analysis. This can lead to poor trading choices, such as chasing losses or exiting profitable positions too early. The inherent uncertainties and quick decision making required can lead to significant stress, affecting mental health and decision making ability.
Trading volatile stocks requires a high level of attentiveness, discipline, and readiness to act quickly, as well as a thorough understanding of both the opportunities and the significant risks involved.
The Bottom Line
Volatile stocks are attractive to traders because of their quick profit potential. Trending volatile stocks often provide the greatest profit potential, as there is a directional bias to aid the traders in making decisions. Keltner channels are useful in strong trends because the price often only pulls back to the middle band, providing an entry. The downside is that, once the trend ends, losing trades will occur. Monitoring price action and making sure the price is making a higher high and higher low before entering an uptrend trade (lower low and lower high for downtrend trade) will help mitigate this defect.
Volatile stocks don't always trend; they often whip back and forth. During a range, when the stochastic reaches an extreme level (80 or 20) and then reverses back the other way, it indicates the range is continuing and provides a trading opportunity. Monitor both the stochastic and Keltner channels to act on either trending or ranging opportunities. No indicator is perfect, however; always monitor price action to help determine when the market is trending or ranging so the right tool is applied.