Is the recent stock market volatility unusual?

Before I answer that question, let me try and explain what volatility in the stock market really means. To the ordinary investor, volatility may mean sudden and unexpected changes in a stock’s price (or an index level).

But aren’t fluctuations in stock prices and index levels the norm rather than the exception? That’s an easier question to answer. Yes, stock prices and index levels do fluctuate all the time. But some times, the fluctuations are tolerable and ‘normal’. Those are periods of low volatility, which are conducive for trading and investments.

At other times, there are extraordinary and nerve-wracking fluctuations in stock prices and index levels that send traders and investors scurrying for cover. Such periods of high volatility increases risk and decreases returns.

For the mathematically inclined, volatility is a statistical measure of the uncertainty or risk associated with changes in a stock’s price (or an index level). It can be measured by using the standard deviation or variance (i.e. two standard deviations) of the returns from a stock or index.

A measure of the overall volatility of a stock’s return benchmarked against an index is called ‘Beta’. A Beta value of 1.0 means the stock’s return is the same as that of the index. In other words, if the index gains 100%, the stock will gain 100%. A Beta value of 1.5 means a stock will gain 50% more than the index during bull periods, but lose 50% more during bear periods; a value of 0.8 means the stock will gain 20% less than the index in a bull market, and lose 20% less in a bear market. The higher the Beta value, the more volatile the stock.

For the technically inclined, the Nifty VIX chart indicates the implied volatility (IV) of a basket of Nifty put and call options. A high VIX level (above 30) indicates high volatility; a low VIX value (below 20) indicates low volatility. Typically, when the VIX rises, the Nifty falls. The VIX can be used as a contra-indicator. Low values give an opportunity to sell, and high values provide opportunities to buy.

What causes high volatility? Unexpected changes - in interest rates (repo, reverse repo) or oil prices; a war or terrorist attack or earthquake; a change of government - can lead to wide fluctuations in stock prices and index levels.

What can small investors do? Understand this simple thumb-rule. Volatility declines when stock markets rise, and increases when stock markets fall. In a bear market – like now – high volatility is not unusual.

That is one reason why small investors may be better off staying away instead of trying to make a few bucks on counter-trend rallies; and avoid averaging-down during bear markets.

That was the long answer. The short answer to the question is: No.

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What is causing the volatility in the Sensex?

Why good investment stocks may not be good trading stocks – and vice versa

The hundreds of stocks that are regularly traded in the BSE and NSE can be broadly separated into three groups – stocks that are good for investment; stocks that are good for trading; and, stocks that are plain junk and should not be touched.

Regular readers of this blog know that I’m neither a great fan of short-term or day trading, nor do I encourage small investors to do so. The only person that gets rich is the broker. No wonder various internet investment groups are full of brokers constantly giving short-term buy and sell calls.

However, it is a fact of life that small investors fall prey to the lure of making quick and easy money, and frequent investment groups and web sites that offer ‘free 100% sure-shot short-term calls’ as a short-cut to untold riches.

I was taken aback when I read read about a short-term sell call on Titan Industries. If the stock falls below a certain level, then it could fall by a whopping 2% more! However, if it rises above a certain level, then the uptrend will resume. A quick look at Titan’s 2 years closing chart pattern shows a more than 50% gain from its Feb ‘11 low, followed by a 3% correction that must have triggered the call.

Titan has gained 300% in 2 years, providing fabulous returns to long-term holders. Any sensible broker would have given a ‘buy the dip’ call instead of a short-term sell call for a paltry 2% profit.

Put it down to ignorance, or inexperience, or both. Many traders believe in the myth that all fundamentals are ‘in the price’ – so it is a waste of time to spend hours in stock analysis.

A trader, if he wants to make money consistently, has to spend hours studying technical charts to try and get into trades that will make huge profits - to cover up many small losses that are part of a trader’s life. Even a novice can take a look at Titan’s chart and conclude that a trade on the long side will be more profitable.

It is precisely because Titan is such a great stock for long-term buy-and-hold investment that it is not a good stock for short-term trading. It doesn’t provide enough wild swings to get in and out with big profits.

Is the vice versa true – that good trading stocks do not make good investment stocks? What is a good trading stock? For the answers to both questions, take a look at the 2 years closing chart pattern of Reliance.

Thanks to its massive market capitalisation, the Reliance stock finds a place in most large-cap and diversified equity funds as an investment-grade stock. But on 2 years, 1 year, 6 months and 3 months time frames, it has provided negative returns.

The rounding-top bearish pattern of the 200 day EMA, and the 50 day EMA trading below the 200 day EMA for the past five months are clear indications that the bears are getting the upper hand.

Experienced traders probably got seriously rich just by trading Reliance over the past couple of years. Look at the frequent and large price swings – just the kind of chart that should make traders rub their hands in glee.

The moral of the story? Whether you are a trader, or investor, or both – it improves your chances of making big money if you do your homework in selecting stocks.