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Surely you've heard me say this before...
"Volatility is a trader's best friend."
But let that sink in for a minute, and I'll explain to you why you should like volatility.
First, let's establish that there are two different approaches to investing.
Investors: These are people who make investments with longer-term outlooks. They buy or sell stocks based on fundamental and technical analysis. They typically take a buy and hold approach and are happy beating the market over the long run.
Traders: These are the people who are trading with shorter-term outlooks. You could be trading for a few hours, or even minutes (day trader), all the way out to trading with an expected holding period of a month - or even two (swing traders).
Traders tend to use more specific indicators that are tuned in with the specific holding period that works best with their approach.
For the record, I fall more into the swing-trader category, with a trading window of 24 days as my most effecting range. I use the 20-, 50- and 200-day moving averages as my trinity of trendlines and also utilize the 20-day RSI. I include the use of several proprietary models that focus on breakout potential and how the options market is positioned on a stock.
There's Also Another Big Difference Between Investors and Traders...
In general, investors dislike volatility. When the market, or a stock, gets volatile and starts to see extreme price swings, investors tend to worry. They prefer a smooth ride on a bullish trend. They like to set it and forget it, not have to read about their stock or worry about the fact that it may fall 15% in a week.
On the other hand, TRADERS LOVE VOLATILITY. As I've already said, "volatility is a trader's best friend." That's one of my Ten Commandments of Trading, and it's been true of traders since before I even knew what the market was.
You see, because traders are looking for a quick move to cash in on profits, they actively look for situations where a stock might enter what I call a "volatility surge," or "volatility storm." That's when a stock goes from being relatively quiet to moving aggressively.
Think about this for a second...
The average return for the S&P 500 is somewhere around 10-12% a year. "Investors" are ecstatic to get a one-year return of 18%. I mean, that's 50% more than the average. You're going to retire early at that rate, right?
Well the average "trader" wants to find the opportunity to grab that 10-12% in a much shorter period - maybe 10-20 days. And then do it over and over, compounding their returns and making that 18% look like a gratuity. You only get that by finding volatility in the market BEFORE it happens, and then harnessing it.
Here's How I Find Volatility BEFORE it Happens...
It's MATH silly. If you didn't know it, I'm a bit of a math nerd. That's a good thing, because the …
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About the Author
Chris Johnson is a highly regarded equity and options analyst who has spent much of his nearly 30-year market career designing and interpreting complex models to help investment firms transform millions of data points into impressive gains for clients.
At heart Chris is a quant - like the "rocket scientists" of investing - with a specialty in applying advanced mathematics like stochastic calculus, linear algebra, differential equations, and statistics to Wall Street's data-rich environment.
He began building his proprietary models in 1998, analyzing about 2,000 records per day. Today, that database, which Chris designed and coded from scratch, analyzes a staggering 700,000 records per day. It's the secret behind his track record.
Chris holds degrees in finance, statistics, and accounting. He worked as a licensed broker for 11 years before taking on the role of Director of Quantitative Analysis at a big-name equity and options research firm for eight years. He recently served as Director of Research of a Cleveland-based investment firm responsible for hundreds of millions in AUM. He is also the Founder/CIO of ETF Advisory Research Partners since 2007, noted for its groundbreaking work in Behavioral Valuation systems. Their research is widely read by leaders in the RIA business.
Chris is ranked in the top 99.3% of financial bloggers and top 98.6% of overall experts by TipRanks, the track record registry of financial analysts dating back to January 2009.
He is a frequent commentator on financial markets for CNBC, Fox, Bloomberg TV, and CBS Radio and has been featured in Barron's, USA Today, Newsweek, and The Wall Street Journal, and numerous books.
Today, Chris is the editor of Night Trader and Penny Hawk. He also contributes to Money Morning as the Quant Analysis Specialist.