As with most things in life, when it comes to stock volatility, there is good volatility and bad volatility.
Last week, we looked at how higher stock volatility levels can be a strong indicator of future potential growth in certain stocks. Not all volatility is created equal, however. It’s important to be able to distinguish between when higher volatility is temporary … and when it is permanent.
A great example of temporarily higher stock volatility is one that we looked at last week – Northrup Grumman Corp (NOC). In the chart below, we show our Volatility Quotient (VQ) indicator on NOC at the bottom and the price of NOC at the top.
It’s easy to see how there were several periods of increasing volatility in NOC and that peaks in volatility corresponded with significant lows in the price of NOC.
From 2007 to 2009, the VQ on NOC rose from below 12% to nearly 25% – a gain of over 100%. In October of 2009, NOC triggered a new Stock State Indicator (SSI) Entry signal at about $38 per share. Today NOC is worth more than $250 per share – a gain of over 500%.
That’s the right kind of volatility – temporarily higher volatility that fuels multi-year moves higher in the price of great stocks as uptrends take hold and volatility returns to former levels.
But there’s also the wrong kind of volatility. Just because a stock has high volatility doesn’t mean that you’re going to end up with a winner every time.
Many times, stocks that have consistently high VQ’s are stocks that are almost impossible to make money with.
One of the stocks that fits this description is Stillwater Mining Company (SWC). The average VQ of SWX over the past 20 years is 47%. That’s way too high!
SWC is a stock that’s almost impossible to make money with. There are no multi-year moves higher here. There is no fuel that can cause this stock to take off. And once the stock does generate SSI Entry signals, there is no momentum that will take it to new highs.
Here are the last 10 years of SWC according to the TradeStops system. The stock has generated new SSI Entry signals 4 times. Only one time has this signal been profitable.
Another example of permanently high volatility is Sarepta Therapeutics, Inc (SRPT). This is a stock that has an average VQ of close to 60%. Because the average VQ is so high, there is no way that the stock can generate enough momentum to make a large move higher over a long period of time.
Predictably, the SSI signals for SRPT have not led to the long-term, stable, multi-year moves higher that we’re looking for.
Now, let’s look at the chart for Extra Space Storage (EXR). The Volatility Quotient of EXR skyrocketed to 50% during and after the financial crisis from its average VQ of 26%.
In June 2009, EXR triggered an SSI Entry signal at around $6.30. As the volatility declined, the momentum increased. EXR exploded higher for more than 7 years and finally hit its SSI Stop signal in September at a price of more than $78. That’s an 1100% gain.
So, as you explore this idea of higher volatility as a trigger for multi-year moves higher, keep an eye out for temporarily high volatility and make sure to stay away from permanently high volatility.
Here’s to smart speculation,
