How to Trade Volatile Stocks
A volatile stock, by definition, is a stock than moves more than the market in either direction, offering traders substantial profit opportunities but also opening them up to sudden large losses. Volatile stocks are typically small cap, lower priced and trading a few hundred thousand shares a day. Knowing how to trade them is as much about knowing what to do as about what not to do.
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Instructions
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Make sure you can watch the stock throughout the day before attempting to trade it. Volatile stocks can move fast; and a strong up or down move can start and end at any point. Unless you are there to catch it, you may miss the opportunity to buy or sell.
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Use daily or intraday charts to determine the exact buy and sell points. Timing is critical in a fast moving stock. If you buy and sell at the wrong time, you may end up losing money in a rising stock-not a pleasant prospect.
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Get your account approved for day trading, if you can. You will need $25,000 in equity and to meet certain other criteria to qualify--ask your broker. You don't have to risk the entire $25,000, but it's important to be approved for day trading even if you are not planning to day trade because you may buy and sell a volatile stock several times during the day. If your account is not approved for day trading, your broker may flag you as a pattern day trader and block your trades.
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Make sure you have plenty of equity in your account if you are using margin. You don't want wide intraday swings to trigger margin calls.
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Decide how much you are willing to risk in a volatile stock and stick with the amount. We all want to get rich sooner rather than later and hindsight is always 20/20 if you make money in a stock, but if it moves against you, a fast move can devastate you financially. Excessive volatility also makes people nervous and causes them to over trade, sometimes to the detriment of profits.
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Give the stock enough room to do what it sets out to do. A "normal" move in a volatile stock may be a lot more than in the market and to make money in a volatile stock you must hold through volatility.
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Leave the stock alone if you missed the correct buy point; otherwise, if you buy an extended stock after a quick run up, you may find yourself down 20 percent when it pulls back in a consolidation.
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Tips & Warnings
Don't place overnight orders. A backlog of overnight buys will give market makers an opportunity to gap up the stock at the open, filling your order at the highest price of the day and leaving you with an instant loss after the gap is "faded," or closed. Conversely, your overnight sell may get filled at the lowest price of the day, after which the stock will recover, leaving you behind.
Avoid placing limit or stop orders. They are visible to market makers, who can move the stock just to clear out all the accumulated orders, after which the price will return to normal.
Do not attempt to day trade a volatile stock unless you know what you are doing.
References
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