Tuesday, June 21, 2011

How To Use the Most Volatile Stocks List

I had a trader ask me how to use the "Most Volatile Stocks List" last week so I wanted to give an example of how I use it.  This might not work for everyone, risk management is key, experience is key, and I'm not giving investment advise.  This is purely educational.

The post: Volatility = Opportunity is posted everyday and screens for names that trade over 1MM shares of stock, over 5k options, and has an implied volatility (IV) over .6.  We post the top 20 because... well that's what we use.


Here are the names that were over $10 from yesterday's scan:
RIMM
HRBN
SINA
FAS
MCP
KNKD
SPRD
REE
DANG
QIHU
(sub $10 names just don't move that much so its better for scalping only)

So we get a list of names that we know are volatile and trade some ok option volume.  The most basic type of trade is the "Opening Range Break" trade.  It's an intra day swing trade.  Lets set some ground rules.


  • Buy or Sell the opening range break. (in our example we'll use stock but I prefer options)
  • Risk 1x to make 2x. 
  • Always use a hard stop & move your stop to break even ASAP. (recognize you will be stopped out of trades that end up working... and that's ok!)
  • Check to make sure the trade is realistic before entering (its ok to pass on a trade) 
  • Focus on risk


Lets start with RIMM.
As you can see in the above chart (from FreeStockCharts.com) RIMM's opening range today was 26.74 to 25.92.  So we're looking to buy 26.75 or short 25.91.

Is the trade realistic? What about our risk? We have the entry but what about our exit?


Realistic? Looking at the chart above you can clearly see that price was making lower lows; yet momentum and RSI are making higher lows.  Bullish divergence. Doesn't mean its going to bounce but it does mean that institutional traders MIGHT be thinking about covering their shorts. Also, RIMM gaped down after they reported earnings last week and has a huge gap higher.  What does this mean? Simply put it means that short are up huge and COULD be looking to take profits. Also the QQQ's broke their opening range today right at 10:01 (same with SPY, IWM, EEM, TLT, VIX, etc).  Which was a great clue that RIMM would break its opening range (savvy traders actually could have got long .25 lower if they bot RIMM on the QQQ's break...but that is more advanced) So I would say this is a realistic trade.

Risk? Ok so we're long at 26.75 (at 10:08 AM PST... plenty of time to set the trade up)  At minimum risk 1x to make 2x.  If you don't think that will happen PASS ON THE TRADE.  There will always be another trade.  At this point I'm not even thinking about profit. I'm thinking about risk. Where can I place my stop?

Idea #1 Stop under the low of the 10 min bar 
26.22 (low of the 10 min bar)
26.75 (entry) - 26.21 (stop) = .54 = RISK
(RISK*2=1.08) gives a target of: 26.75 entry + 1.08 profit target = 27.83 price target

Idea #2 Stop under the low of the 15 min bar
26.35 (low of the 15 min bar)
26.75 (entry) - 26.34 (stop) = .41 = RISK
(RISK*2=.82) gives a target of: 26.75 entry + .82 profit target = 27.57 price target

Idea #3 Stop under the low of the 30 min bar
25.92 (low of the 30 min bar)
26.75 (entry) - 25.91 (stop) = .84 = RISK
(RISK*2=1.68) gives a target of: 26.75 entry + 1.68 profit target = 28.43 price target

Exit? Which is the best trade? Well lets look at the chart.  As you can see below there is an open gap from 27.75 to 27.35.  Also a quick check of the support and resistance levels and you'll see that the pivot point was at 27.68 and R1 was at 29.45.

Trade idea 2 is looking the most realistic given where the gap is and where the pivot point is located. Therefore lets set our stop at 26.34 and target 27.57 or better.


As you can see the trade worked.  There are all kinds of different strategies you could have done to enhance the trade.  Selling calls against long stock, buying puts against long stock, using options instead of stock, risk reversals, keeping a runner, scalping in more edge, etc. but we'll save that for a later post.

What about our list?
RIMM - target hit
HRBN - no trade, didn't break out with market
SINA - target hit
FAS - target hit
MCP - no trade, no break of opening range
KNKD - target hit
SPRD - broke to the downside but I wouldn't go short in a market up trend day
REE - broke to the downside; again wouldn't short in a trend up market and the range broke late
DANG - no trade
QIHU - probably a small loss or break even trade

Not a bad day for the Most Volatile Stock List...4 winners, 1 loss/scratch, 5 no trades.

Please note that not every day is this good.  Trend days always work better for this style of trading.  Some set ups have to much risk and unrealistic target prices. Its very important to have the discipline to pass on those.  Some days I scratch all of the set ups and end up just paying a lot of commissions. Some days I take losses on all my set ups.  That's part of trading...get use to it.

FreeStockCharts is good to share info but I don't use it to trade.  Having good trading software ought to give you chances to scalp more edge into your trades.  Commissions are extremely important to keep as low as possible. I can recommend brokers if you want.  Trading isn't easy but if you focus on risk first I hope that you see the odds will be in your favor.

Complaceny Killls!  Know your options!

Good luck and trade 'em well.  As always if you have any questions please feel free to ask.

http://seaofopportunity.blogspot.com/

 *Special thanks to Option Radar, BMO Capital, MEB Options, LiveVolPro, CBOE, Option Monster, T.O.P. group, and all of the options desks and traders we work with to provide the option flow!

 No position at this time. Position declarations are believed to be accurate at time of writing but may change at any time and without notice.

3 comments:

  1. WOW!!! that's brilliant idea of using volatile stocks. Free Stock Charts is good to share info but I never use it to trade.
    where to buy stocks

    ReplyDelete
  2. WOW!!! that's brilliant idea of using volatile stocks. Free Stock Charts is good to share info but I never use it to trade.

    ReplyDelete