Volatile Stocks: How To Identify Them?

Investing in the stock market involves navigating through various types of stocks, each with its own risk and return profile. Among these, volatile stocks stand out due to their price fluctuations over a short to mid-term timeframe. Volatility refers to how a stock’s price moves up or down in a given period. Highly volatile stocks can swing sharply in value within days or even hours. This makes them risky for investors.

In this article, we’ll explain what volatile stocks are, why stock volatility matters in the stock market, how to identify such stocks, and the tools and strategies to find them.

• Table of contents

• Understanding volatile stocks
• Importance of stock volatility
• How to find volatile stocks
• Volatile stock examples in India
• Risks and rewards of volatile stocks
• Tools and strategies to track volatility

Understanding volatile stocks

Volatile stocks are essentially stocks that experience large price fluctuations. These movements can be influenced by various factors, including market sentiment, economic indicators, and company-specific news. In technical terms, stocks with a beta value greater than 1 are often considered volatile. Beta measures a stock’s volatility in relation to the overall market. A value of more than 1 means they tend to move more than the overall market.

Additionally, standard deviation is a statistical measure that tells you how much a stock’s price moves away from its average price over a specific period. A higher standard deviation indicates a more volatile stock (larger price swings). A lower standard deviation indicates a more stable stock (smaller price movements).

A stock could be volatile due to positive excitement or due to negative uncertainty. Investors often look at volatility through daily price ranges, percentage changes, or technical indicators. What defines volatile stocks is the magnitude of their price swings, not the direction.

Importance of stock volatility

Volatility is an essential concept in investing because it signals risk. For aggressive investors or short-term traders, this price fluctuation presents a chance to earn potential returns from swings in stock prices. On the other hand, conservative investors might be wary of such stocks as they seek to reduce volatility in their portfolios for potential stability of capital.

Volatility also influences investor behaviour and strategy. For short-term traders, volatility is often welcome, rapid price swings mean more chances to potentially capitalise on price differences.

However, for long-term investors, the same volatility can be stressful – sharp ups and downs can make it harder to stay invested and may lead to emotionally-driven investment decisions.

Volatility in the stock market is often seen during budget announcements, interest rate changes, or geopolitical events, which may in turn affect individual stock movements. High volatility doesn’t automatically mean an investment is fundamentally unsound, but it does mean the ride will be bumpy. Therefore, investors must assess if they have the risk appetite and time horizon to weather those swings.

Read Also: Mutual funds and stock market volatility

How to find volatile stocks

Finding volatile stocks requires more than gut instinct. Several indicators and data points help measure volatility:

• Beta value: Beta compares a stock’s movement relative to a benchmark index, like the Nifty 50. A beta greater than 1 indicates higher volatility compared to the index. For example, a beta of 1.5 means the stock tends to move 1.5 times the market.
• Average true range (ATR): This technical indicator captures the average range of price movement over a defined period. A higher ATR signals more frequent or larger price swings.
• Historical volatility: Look at a stock’s 52-week high and low prices. A wide gap between the low and high indicates that the stock has seen big swings over the year, a sign of volatility.
• Volume surges: Sudden spikes in trading volume can indicate increased investor activity and price shifts.
• News sensitivity: External factors can make a stock volatile. Stocks that react strongly to earnings reports or government policies often exhibit high volatility.

Volatile stock examples in India

Small cap stocks and mid cap stocks tend to be more volatile, as these companies are smaller in size, which often means less stable earnings and lower trading volumes. In India, many stocks in sectors like technology startups, banking, or infrastructure have shown high volatility during market cycles.

Risks and rewards of volatile stocks

Investing in volatile stocks may offer the potential for wealth creation for those who understand their nature and are willing to stomach the high associated risk. However, they come with both potential gains and risk of losses.

Rewards:

• Short-term opportunities: Price movements can be leveraged through trading volatile stocks strategies such as momentum or breakout trading.
• Portfolio diversification: A limited exposure to volatile stocks may offer higher potential returns when other parts of the portfolio are relatively stable.

Risks:

• Unexpected losses: Sudden market reversals can lead to quick loss of investment value.
• Emotional decision-making: High volatility may trigger impulsive buying or selling.
• Liquidity issues: In volatile stocks, exit might be harder during periods of distress.

Hence, risk management becomes essential when engaging with volatile instruments.

Tools and strategies to track volatility

Investors today have numerous tools to track volatility, both at the market level and for individual stocks.

• Volatility index (India VIX): India VIX represents expected market volatility over the next 30 days. A higher VIX generally means more uncertainty.
• Smart beta investing: Smart beta funds are passive funds that pick stocks based on certain factors. One factor is the low volatility factor.
• For stock-specific volatility tracking: Apart from the indicators like beta, ATR, etc., one can use screeners and analytical tools. Websites and trading platforms often have built-in screeners for the most volatile stocks or allow sorting by daily percentage change. These can quickly highlight which stocks had big moves on a given day.

These tools, when combined with personal risk assessment and knowledge of market volatility, can help investors make more informed decisions.

Read Also: How investors can prepare for market volatility with India VIX

Conclusion

Volatile stocks can be both exciting and intimidating. For investors looking for potential opportunity through either intraday trading or short-term trading strategies, volatility can provide many entry points. However, for long-term investors, volatility must be managed rather than chased. Hence, it is crucial to identify volatile stocks through quantitative indicators, using stock volatility tools, and adopting strong risk management strategies.

FAQs:

What causes a stock to be volatile?

Volatility in a stock arises from sharp price movements, influenced by factors like market sentiment, earnings reports, macroeconomic changes, and sector-specific news.

How do traders profit from volatility in a stock?

Traders use volatility to look for quick price movements, which they aim to profit from. In order to potentially profit from volatility, traders will often use tools like ATR and beta values to determine their entry and exit points.

Is volatility good, or bad in stock trading?

Volatility is neither good, nor bad. Active investors can use volatility for potential profits, but higher volatility typically carries a higher risk of potential capital losses. It all depends on your trading strategy and risk tolerance.

Which tools help to track volatility?

Key tools include beta values, standard deviation, average true range (ATR), India VIX, and charting or technical analysis tools available from your broker.

Is a volatile stock a good long-term investment?

In general, long-term investing prioritises investments in reasonably predictable businesses that offer steady cash flows. That being said, some volatile stocks may deliver wealth creation potential by offering long-term growth in business. Investors should carefully assess the company fundamentals and the rationale behind the investment, aligning decisions with their risk tolerance and goals.