Category Archives for "Daily Commentary"

While looking for references for an article on stops, I came across this piece, originally published in TRADERS August 2015. Since it’s relevant in these volatile times, I thought now would be a good time to publish it here (originally re-published in July 2020). 

The Devil You Know

Many trade less volatile stocks under the guise of avoiding risk. Ironically, they might be creating it. Within reason, you’re much better off trading more volatile stocks. It truly is “better the devil you know.” Let's look at how to measure and gauge a stock’s volatility and why you should generally trade more volatile stocks.

Measuring Volatility

Before we get into math, know you don’t have to worry about it. Just like you can get light by flipping a light switch without knowing much about electricity, you can look at the volatility reading to see how volatile a stock is, or more accurately, was. Volatility is how much a stock has bounced around in the past, and it suggests how much it will continue to bounce around in the future. Let your computer do the math for you, and never forget to first and foremost simply “eyeball” the chart to help gauge volatility.

Keep in mind that statistics are worthless. 75.3% of all people know this. Seriously, statistics are pretty much worthless when it comes to the markets. In order for statistics to work, markets would have to be normally distributed. And, they are not. We’ll leave the well-thought compelling arguments to others. For purposes of this article, the argument is simple: If statistics truly did work, those with the most knowledge of statistics or the fastest computers would own the markets.

Next to just looking at the chart, my favorite volatility measurement is historical volatility (HV), occasionally referred to as statistical volatility. HV is the standard deviation of day-to-day price changes expressed as an annual percentage. Assuming that a market had a 50-day HV reading of 20. Since it is an annualized measurement, this would suggest on a statistical basis that if the volatility remained constant, then the market measured would have a 68% chance (on standard deviation) of trading being 20% higher or 20% lower a year from now based on how it has traded in the previous 50-days. It is almost an absolute certainty that volatility will not remain constant. And, the measurement assumes a normal distribution (i.e., that statistics work in financial markets, which is a fallacy). However, even with the flaws of using a statistical indicator on something that isn’t normally distributed, knowing the HV of a market can still be quite useful.(1)

Based on the aforementioned reasons, using HV as a precise predictor of where a stock will be in the distant future is not a good idea. However, using it to gauge where the stock will likely be over the short-term can be quite useful.

It’s All Relative

When using HV, the easiest way to understand the true volatility is to compare it to the overall market. This is very similar to so-called “Beta” measurements. When this article was first published (summer of 2015), the volatility of the S&P was 10. As of Thursday, 07/02/20, the HV was 26 (28 as of 06/17/25). Stocks with a reading above 26 have been more volatile than the market, and stocks with an HV reading below 26 have been less volatile than the market.

Again, notice the past tense. The stocks “have been” more or less volatile than the market. This is why the formula has the word “historical” in the name. As Yogi said, “Predictions are difficult, especially about the future.”

What Is The Right Volatility?

I’m often asked what volatility reading potential candidates should have. The answer is that it depends. The overall market’s volatility waxes and wanes. So, start there. As a general statement, you cannot beat a market with stocks that do not move more than the market itself. Therefore, at the least, you want to trade stocks that are more volatile than the overall market. I’m finding the best opportunities in stocks with HV readings in the 30-60 range (summer of 2015). These stocks are 3 to 6 times more volatile than the overall market basis the S&P benchmark (note: as of 06/17/25, most of the potential stocks are much higher, between 50 and 100).

The ultimate goal is to make money as fast as possible. With less volatile stocks, you’ll have to wait longer for moves. And, of course, something bad can still happen. Therefore, in general, you want to avoid stocks with an HV less than 20. They simply don’t move enough. On the upside, you can have too much of a good thing. Usually, unless there is structure (read further) and a great setup, you should avoid stocks with an HV reading greater than 100. Once in a stock, you are looking for an increase in volatility in the direction of the trend. Again, you want to make money, and fast. The faster the move, the greater the expansion in volatility. If the volatility is already extreme, one has to wonder how much more it can expand. Also, once volatility gets too high, the chances for the stock to still have meaningful structure (tradable patterns vs. trading erratically) likely no longer exist.

Exceptions To The Norm

There are some exceptions to “too low” or “too high” volatility readings. Persistency of trend--a good thing--tends to reduce volatility readings. Also, sometimes big cap stocks with low volatility readings are poised to roll over. I have developed specific strategies around these anomalies (Persistent Pullbacks and the “Go Go No Mo”, respectively). On the flip side, sometimes extremely volatile stocks can still have structure and make large moves. These are stocks that by nature tend to be volatile such as rare earths, small high tech companies such as biotech, and many IPOs. Note, circa June 2025, other examples would be small-scale nuclear, quantum computing, Crypto, and A.I.-that's two letters that stand for "artificial intelligence."

The Devil You Know

In general, I’d much rather trade a more volatile stock than a less volatile one. If you know that a stock has made sizable moves in the past, you know that it will likely make sizable moves in the future. And, a stock must move in order for you to profit, period. Write that down. Therefore, you are much better off trading those that have demonstrated their ability to make large moves, within reason. Of course, all predictions are about the future, and there’s no guarantee that they will continue to move, but your chances are generally much better in capturing a move in a more volatile stock than a less volatile one.

No Safe Haven

Some convince themselves that they are taking less risk by trading less volatile stocks. Yet, in order to get the money management right, you have to trade more shares. Let’s do the math. Assuming you will enter at a price of $44 per share (see chart 1). Referring to the spreadsheet below, let’s suppose you determine that your stop will be 1 point away from your entry. Based on a 100k account risking 2%, you would buy 2,000 shares of stock: (100k *2% = 2,000/1=2000). With an entry of $44, this means that 88% (2000 * $44=$88,000) of your account will be tied up in just 1 stock. Now, let’s say something really bad happens. Suppose the stock gets halved overnight. You’re not faced with a 44% loss on your entire account. Just to get back to breakeven, you’ll have to make back nearly 79% on subsequent trades. Such drawdowns can be devastating not only monetarily but also mentally.

True, large moves are less likely to happen in stocks with lower volatility readings, but something bad can always happen. This doesn’t have to be a massive terrorist attack or a small country in the middle of the Mediterranean defaulting on its debt. It can be something as simple as an impropriety by a CEO. Ironically, I made that hypothetical example in The Layman’s Guide To Trading Stocks (get it here for free). Then, two days after the book was off to the printers, a CEO of a sleepy, well-established “boring” company decides to start chasing his secretary around the desk. He reasoned that since she was an ex-porn star, she wouldn’t mind some sexual advances. Okay, she was a soft porn star but you get the idea (I go to great lengths to make sure that my research is precise. It was difficult explaining that search history to my wife, Marcy). The company lost 10 billion in one day just because a CEO couldn’t control his libido. The volatility tripled overnight. So, keep in mind that something can always go wrong. Stocks with very low volatility appear quiet and safe on the surface. However, they can still make large adverse moves. Shit happens-"Sometimes twice" as the woman a biscuit shy of 300lbs once said while I was checking out at Wally World. 

One Size Fits All?

One more point. There’s a popular method that recommends using an 8% stop in all stocks. This type of statement would be like saying that everyone should wear a medium size shirt—something my fat ass hasn’t been able to do since I was 5-years old. Now you know why I have the nickname “Big Dave.” In many cases, using a tight stop will virtually guarantee you a loss. Yet, in spite of this, tight stops seem to be universally preached.

I have helped many unsuccessful traders who were repeatedly stopped out by simply suggesting that they loosen their stops. They are now catching more and more trends. 

But Wait, An 18% Stop?

Let’s take a look at a volatile stock that I recommended. It had an HV reading of 77% while the S&P 500 had a reading of 14%. So, the stock was 5 ½ times more volatile than the overall market. Eyeballing the chart, you can see even though the stock tends to trend higher, it does so with large daily ranges and day-to-day movements. In other words, it has been volatile. Taking the high HV into consideration along with simply “eyeballing” the price movements, I determined that trading the stock would require at least an 18% stop from the entry. Now, this might seem extreme to some, but that’s what the stock called for. In fact, notice over the next few days that the stock dropped 18% as measured from high to low just before it took off. A one-size-fits-all 8% stop would have gotten taken out quite easily. You would then have to watch in agony as the stock takes off without you.

Referring back to the spreadsheet (scroll up), notice (highlighted) that with an 8 point/18% stop distance based on 2% risk of a 100k account, only 250 shares should have been traded to keep the risk in line. True, 11% of the account in one stock is still significant, but nowhere near 88% of the account based on a 1-point stop. Now, like our previous example, let’s say the stock gets a 50% haircut overnight. A 5.5% loss (11%/2) is nothing to sneeze at, but at least your account will survive, so you can trade another day. Also, psychologically, a 5.5% loss is much easier to stomach than losing nearly half of your account by trading more shares with a tight stop.

Below is an open example (as of 06/18/25). The original stop on TFPM was 13% away from the entry. The stock had a 12.83% drawdown (peak to trough), coming dangerously close to the protective stop. In this case, 13% was barely enough. Also, notice the recommendation for today has a 28% stop! For reference, the stock's 50-day HV is 102. 

You Want Comfort? Buy A Comforter

Many refuse to trade more volatile stocks because they “can’t risk that many points or percent.” Yet, that’s exactly what they should be doing. Just make sure to compensate by trading fewer shares.

Volatility IS A Good Thing, But Don’t Forget About Structure

Just because a stock is volatile doesn’t mean that you should blindly trade it. Stocks should not only be volatile, within reason, but also have three things:

1. Structure

2. Structure

3. Structure

By structure, I'm referring to the characteristics of the chart that would suggest that the new or emerging trend will likely continue. Always look for structure. Are there big-picture patterns such as cup and handles, bases, or double/triple bottoms? Does the stock trend to trade cleanly and persist, or does it look like an electrocardiogram? Is the trend accelerating or decelerating? Where is the stock on a “net net” basis?—In other words, where did it close today relative to 1-week ago, 1-month ago, and so forth? This might seem quite obvious, but I often get emails about a potential setup in a stock that hasn’t made any forward progress in months.

In Summary

By seeking to avoid risk, many may be creating it by trading less volatile stocks and/or by using too tight of stops. More volatile stocks, within reason, can offer better opportunities and can be less risky than those that are less volatile. It truly is the better devil that you know.

Notes and References:

HV Formula (from Dave Landry on Swing Trading)

Let Length = length of volatility to be calculated and ln = natural logarithm

Historical Volatility(length) = standard deviation(ln(close/yesterday’s close),length)*100*square root (number of trading days per year, approximately 256).

(1) Dave Landry on Swing Trading (2000)

(2) See Free Reports at davelandry.com

(3) May 2015 issue of TRADERS’: The 1X1 Of Stock Picking by Dave Landry, See Free Reports