It’s important to know a stock's historical movements over time. Referred to as high and low statistical volatility, these numbers depict a stock's trading range over a specific time. Basing stock picks on past performance can reduce your risk, and calculating a historical high and low volatility ratio may help you trade profitably.
1. Identify the lowest price at which a stock traded in the past year and the highest price that it hit during the same period. Place the current stock price as well as the high and low prices for the year on a graph and draw a line from the lowest to the highest. For example, if a stock’s year low was $90 and the high was $110, and it is currently selling for $100, the historical probability assumes that it will fluctuate between $90 and $110 over the coming year.
2. Extend your research to include price fluctuations at different times during the day along a specified timeline. For example, compare the lowest opening stock prices over a year versus the closing prices used for the standard calculating techniques. Create a scale that depicts the drift that occurred during a single day of trading and gauge the variations on your timeline. By increasing the number of variables included in your calculations, you reduce the margin for error.
3. Presume that the higher volatility between the two extremes could lead to the greatest variations in the near future. Alternatively, the lower the volatility in the previous year’s performance, the less risk of volatility in the coming year.
4. Factor in the current economic climate to determine the implied high or low volatility in the market. Market analysts and the financial media can give you an idea of the current sentiment regarding various industries. For example, despite a fairly even historical volatility rating in commercial property, public sentiment over the continuing devaluation of real estate adds to the volatility factor, leaving stocks in this sector more vulnerable and thus cheaper.
5. Expand your timelines to two, five and 10 years to view major changes and stock stability for large cap stocks owned by institutions. Lower-priced and lesser-known stocks are usually subject to day-to-day volatility, while large corporations’ rate of volatility also includes long periods of stability.
- Use historically low periods of volatility to find the best stock deals. For example, if a stock hits an historical low at a time of widespread malaise in the market, you can be reasonably sure that, barring unfavorable news, the stock price will follow its traditional path and soon begin to rise.
- High and low statistical and implied volatility should only be used as a guide, as the stock market can swing widely for short periods of time, skewing your results. An abnormal high, for example, could lead to a higher volatility ratio when, in fact, the stock has remained fairly stable over much longer periods of time.
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