Want to know how to determine a stock’s volatility?
- Advanced Average True Range
- Generic Returns Method
- 52-Week High and Low Range
Volatility can be determined either with Advanced Average True Range, Generic Returns Method or 52-Week High Range.
Average true range indicator is the most common technical indicator for measuring the stocks swings.
However, it is not usually used properly causing a lot of problems.
The Generic Returns Method is different because the calculation is based on the recent 12-month return.
The formula was coined by Wesley Gray at Alpha Architect.
His work is on predicting stock returns is unique considering that it is not usually found online.
Another strategy is the 52-week-high method. It is simply deducting the difference between the highest and lowest price in the last 52-weeks.
The difference is said to be not volatile if it is within the 5% to 10% range.
Its range is small and it is a safe stock for most people.
However, safe stocks may not provide returns because its swings from highs and lows is not large.
The swings should be enough to make at least 10% or more in a year.
To make at least 10%, the volatility should be at least 15% or more assuming the trading entries were made within 15%.
The entries are considered to be good if it located within the stock’s volatility range.
For example, a volatility range of 10% may give 9% as long as the entry is within 1%.
However, the entry is difficult to make considering the uncertainty of the stock market.
What is A stock’s Volatility?
A high volatile stock is said to be riskier than the lower ones according to Investopedia.
However, it is not usually true according to some of the best traders in the world.
The best traders often want stocks with large swings to be able to make money consistently.
Stock price swings is measured to find the volatility of a security.
Volatility is mostly important to funds considering the need to generate returns every year.
The need to generate returns is the reason they mostly prefer momentum trading.
Momentum is required in intermediate horizon which is often six to twelve months period.
The period is regarded as important to most funds because they have to have a profitable year.
To have a profitable year, funds should only select moving stocks.
However, it is often difficult to make.
Advanced Average True Range
The ATR is usually attached to a chart to measure the volatility of a stock.
For example, if the value is 0.50 the stock usually swings with that value.
However, is it really helpful to a stock trader?
The video above explains how to use ATR to measure volatility. It also shows how to set stop loss.
Stop loss is usually recommended within three times ATR.
However, how to use ATR to select stocks for trading?
Well, the value of the Average True Range is said to be related to the stock price.
The relationship is important because the percentage is actually used in trading.
For example, a $1 ATR is 4% of $25 stock.
The stock can move about 4% which is suitable for shorter and intermediate trading period.
For short-term trading, higher volatility is recommended to generate returns as soon as possible.
The suggestion can make trading simple instead of just looking at the raw ATR data.
Raw ATR data does not mean anything unless it is compared with the stock price which can be easily done with trading softwares.
A trading software that is often recommended is Amibroker.
Amibroker is the best software considering its advance features at affordable price.
One of its features is the ability to scan the stock market.
The scan can be using the percentage of ATR from the Price and filtering only 4% and above.
Generic Returns Method
In the book “Quantitative Momentum by Wesley R. Gray”, Generic Momentum is calculated by multiplying the last 12 months’ return and deducting one(1).
The monthly return is derived by adding the value of 1 to the rate of change.
For example, if the previous month close has increased by 6%, the monthly return is 1.06.
The previous 12 month return are multiplied and then deducted by 1.
The result of the calculation is the generic return of the stock.
What if the generic return is only 5% or lower?
If the generic return is small, the volatility is considered to be low. (e.g. Between -5% to 5%)
Low volatility is often related to low returns.
As recommended, low returns should be avoided to generate above average return.
Avoiding low volatile stocks means that only stocks having more than 30% generic return may give more opportunities.
As a warning, the book is not about measuring volatility with Generic Returns.
However, Generic Returns maybe a powerful tool to measure momentum and volatility.
52-Week High and Low Range
52-week high and low range is the classic volatility indicator.
The indicator is not usually popular among traders considering that ATR is widely promoted online.
It is widely promoted because it is already available to most charting software.
However, same as the generic returns, the real volatility of a stock is measured in the previous 12 months.
The previous 12 months’ high and low is the actual price move of the stock.