What is Volatility?

Volatility in the context of stock markets is the amount of price change which a stock experiences over a given period of time (i.e. breadth or the difference between high-low). Put differently, if the price stays relatively stable, the stock has low volatility.

A highly volatile stock is one which moves randomly in the absence of any major news-flow and experiences rapid increases and dramatic falls. That said, stock price volatility is often also caused by the random arrival of new information relating to a particular stock. In the post below, I will talk about stocks which are generally volatile and not about the ones which are volatile on a given day because of unexpected events, good or bad news, earnings/ economic reports, political news, world events, etc.

Volatility: An Overall Opportunity

Volatility is an investor’s best friend. Periodic volatility in the stock market is healthy and good for the market. It provides an opportunity to investors to accumulate high quality shares at low price for the long term. It gives investors an opportunity to take advantage of price swings to buy when prices fall below the value of the company and sell when they rise well above the company’s intrinsic value.

In reality however traders use volatility to make quick gains on swing trades without necessarily having a long term view of accumulating the stock.

How to look for Volatile Stocks?

This is a very open ended question. Different market participants will have different definition for what constitutes a volatile stock. Primarily however everyone should/will be concerned about one or more of the following:

To get a list of stocks on any of the above basis, make sure you choose the official stock exchange (BSE, NSE) website. Here are the links:

• NSE India Live Market Report Section
• BSE India Live Market Report Section

Most Volatile Stocks for Swing Trading

If you are a swing trader, you should be looking for 2 things – (i) volume & (ii) Price. It’s pointless to look for stocks which move in a range of 30-50% but are so thinly traded that you cannot trade more than a few thousand rupees in them. At the same time looking only at the ‘A List stocks’ (i.e. stocks belonging to the BSE 200) will give you a list of stocks with enormously high trading volumes but very little price movement. To take an example, the table below shows BSE 200’s most active stocks (arranged volume wise) for 9^th March 2015:

While the volumes are really high the % change and the daily high low is not very wide apart. So while these stocks may make sense for algorithmic traders, if you are in pure swing trading, you may want to look for stocks outside of the ‘A List’. Your intention will naturally be to find stocks which have great breadth in the high/ low prices while at the same time maintaining sufficiently high trading volumes.

But keep also in mind that empirical/ historical evidence suggests that low priced stocks (i.e. below Rs. 100 a share, as you see in the list above) with very high trading volume, will over time deteriorate, i.e. result in losses. So choose them only for short duration trades as they are hardly ever investment grade. I bet 3 years from now, most stocks in the list above will be trading far lower, irrespective of where the market heads.

The correlation between price and volatility will depend upon 2 things – (i) How much money would you like to trade and (ii) how long would you want to hold the stock. If you want to trade Rs. 1000 – even a thinly traded stock will work for you.

“The table below is based on stocks which in addition to being volatile on an intra-day basis have sufficient trading volumes for you to safely trade Rs. 10,000 – Rs. 50,00,000 (Rs. 10 thousand – Rs. 50 lacs) on intra-day basis.”

Methodology:

• Stocks are selected from the top 500 volume generators out of the ~ 3200 stocks trading on the BSE.
• A 30 day average sample (for each of the months from November 2014 – March 2015) was taken for high-low price breadth.
• The stocks in the table below were common on most of the 30 day sample.

Value vs. Volume

While the above discussion and stock selection was based on the volume of stocks traded, keep in mind that for many traders, value may be better criteria.

Look at the table below – while some companies will be common in both the tables, there will be many differences. A stock like Larsen & Toubro which trades @ Rs. 1750 (price on 9^th March 2015) may not generate high trading volume based on the number of shares traded but generates high trading value making it a great pick for swing traders. The important metric to think about is the money which a trader will be trading with (value) more than the number of shares (volume) which can be bought using that amount of money.

A Word on Volatility Index

Both on the NSE & BSE, you will find a volatility index and may be wonder what purpose does that serve?

The volatility index value is the percentage by which investors expect the markets to move in the next 30 days. So, if the value is at 30, investors are expecting the markets to change by 30%.

In 2008, NSE launched volatility index on NIFTY 50 – India VIX – measures market’s implied volatility derived from option prices over the near term.

In 2010, BSE launched volatility index on Sensex – Sensex Realized Volatility (REALVOL) index- aims to provide market participants with an accurate measure of the historic volatility of the 30-stock index over 1, 2 and 3-months time horizons.

Explained simple, both these volatility indices aim to measure the overall market’s expectation of volatility (fluctuation in price) both upside and downside over the near term.

The index has an inverse relationship with the market. So when the volatility index level is low, it implies that investors are optimistic about the market (i.e. most investors are betting that the market will rise in future).

On the contrary, a high volatility index level suggests that investors expect the market to move sharply in either direction.

I could talk about how volatility is calculated but that will be an even longer and somewhat pointless explanation. More simply – it is calculated by averaging out the order book of Nifty options on the basis of the best bid/ask quote of the near and next month Nifty option contracts.

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Rajat Sharma

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