Sensex

Sunday, May 04, 2008

DG - Does Volatility Kill?

Does Volatility Kill?

By Lynn Carpenter

This time we will tackle volatility, which is probably even easier and much more misunderstood.

People who trade options study volatility closely. They hunt it out or avoid it. They massage it and time it. They know it can work for them, or against them, and in either case it strongly affects their price.

In contrast to the option trader, most of us stock investors give volatility very little thought, if any.  

If that's you, you can continue to trundle happily down that path, ignoring the whole issue… if you stick with blue chips and plan to hold them for 20 years, that is.

Otherwise, it would be worth your while to give the subject a little notice.  A great deal of what the experts tell you about stocks and how to handle them is closely linked to their beliefs about volatility and their reactions to it.

But on the more practical level, volatility may also affect whether you are profitable, what kind of stocks you should buy and how you handle your money.

As with the series on trend lines, I am going to break this subject down into rational pieces. You will find that the subject is not abstract at all, and is certainly not as complex as some people would have you think.

Normally, a discussion of volatility in stocks heads right to the deep waters of Modern Portfolio Theory, beta and academic studies. We'll get there, but we'll start at the commonsense end of the subject, before academics chop it up and give each of its parts ten-dollar names.

 

Refer to the attached image.

In the past year, Lockheed Martin and Overseas Shipping Group have both done well and gone up about 12%. In that time, the Dow and the S&P both lost ground. Investors who bought either one of these stocks should be happy with their gains so far.

But I will bet you that many aren't. Lockheed is a little off its peak, but most of all, it was fairly boring. Those looking for big excitement probably weren't satisfied with this nice, steady march.

Overseas Shipping would have troubled even more investors. Even if they were happy to have 12%--as any sensible person should be—the ride was a rough one. The stock was up 35%, it was down 11%, up 15%, down 13%, up 6%, down 15% and finally up 12%.

That's volatile!

In fact, both stocks have volatility, but Overseas Shipping has a lot more of it. On a practical level, spotting volatility is like recognizing good art—I don't have to define it for you. You know it when you see it.

Now, think about using stop losses. Everyone who bought Overseas Shipping when it was getting hot in April to June last year took a loss on the stock if they used a 25% trailing stop.

Everyone who bought the stock in April, most of May or the second week in June who ignored the volatility, stayed off the stop-loss crutch, and stuck around has made money. In fact, there were only 16 weeks in the past year where it was possible to buy Overseas Shipping at such a high price that you would be down today (well, as of April 22, when I made this chart). But only if you did not use trailing stop losses.

Contrast that to Lockheed Martin. A stop loss would have been a nice bit of insurance to comfort the investor who doesn't want to check every position every day. The stock had its ups and downs, but not enough to trigger a 25% trailing stop.

Is this a claim that stop losses are evil? Heck no. But I will proclaim loud and clear that half the people who use them and most of the people who advise them don't think it through. You cannot buy a stock like Overseas Shipping Group if you are not willing to let it wander. This applies to quite a few stocks, most biotechs, for instance. You are, in fact, more likely to lock in a loss than to avoid one if you put a standard trailing stop on a volatile stock.

If you want to use stop losses all the time, don't trade extremely volatile stocks. Period. The two instincts are at odds. Volatile stocks hint at big returns and excitement, not safety. Safety does not usually come on the kind of stocks that smash records.

What We Take from This:

  • In the simplest terms, "volatility" means a stock moves up and down. All stocks are volatile. A stock that moves up and down more than most is "highly volatile."
  • Using a conservative stop loss on a highly volatile stock is a mismatch of purposes. Either you should rethink your stop loss policy or stick with less intimidating stocks.
  • It would be good to have a rule on this—how much volatility is right.

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Regards

BigGains !!
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DG - How to make money in bear market?

How to make money in bear market?

Everyone loves bull markets. In a bull market, every stock will give us good returns. But bear markets test one's real ability, company's fundamentals and investor's patience levels. But Bear markets also provide wonderful investment opportunities if we can able to spot investment chances early. We can make good money in very short term period.

2 types of investment strategies in bear market:

1. Accumulate more on every fall and invest for long term to reap full benefits. Even good stocks will be available at cheap prices in bear market due to bad sentiment.

2. Ultra
short term opportunities. You should always be on alert to utilise these chances. If you enter late, losses will be more as it happened in case of Orchid chemicals investors who entered into that stock at above 300 levels.

Alert: Operators will try to fool investors by artificially rising stock prices by spreading rumours. Be careful with stocks like Ispat, RNRL, IFCI and Essar Oil. If don't have enough knowledge on Stock Markets, stay away from these things. If you are a long term investor, don't buy major stocks at current levels.

Bear markets- best money making opportunities:

1.
Over reaction: When L&T announced minor losses in Forex derivatives, everyone sold it despite strong fundamentals of the comapny. We should see for such opportunities to enter into those stocks.

2.
Sudden options: Orchid chemicals suddenly lost 50% value despite no change in fundamentals. That was due to Bear sterns sell off. We should be always on alert for such chances.

3.
Over enthusiasm: Markets over reacted to open offer and acquisition rumours and took stock price to unreasonable 350 levels. Even if Ranbaxy take over Orchids, 250-280 is reasonable price. We will look for short selling opportunities in such instances.

4.
Buyback offers: In a bear markets, prices generally do not justify its intrinsic value. So companies try to buy back shares at higher prices. Just see what happened in Sasken Communications. Look for good buy back offers.

5.
Never chase operators: If a stock is rising without any reason, simply stay away from such stocks. It is due to operators activities. Never invest in any stock basing on rumours.

6.
Crucial breaks: Some decisions will change company fundamentals to much attractive levels. In these instances, stock price will rise for prolonged period as it happened in Bombay Dyeing.

7. Rallies in bear market generally will not last for prolonged periods. So, make money in
short term and exit that stock.

8.
Short term opportunities will be available in stocks that lost more than 50% in a short period despite good growth. We should identify them early before markets recognise them as it happened in ICSA India and Gujarat NRE Coke.

Investors can't sit idle in bear markets as investors over react to bad news and stocks will lose all the gains in 1-2 days. These ultra
short term opportunities are only for experienced investors who can spend enough time on stock market research and at trading terminal. More companies are planning to buy back shares means we are going to get investment chances to make quick money.

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BigGains !!
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