The most volatile stocks are often the most popular. As a company presents a transformational idea, a battle will emerge between newer investors who believe in it, and older investors who want to see the cash from monetising the idea. As a result, big swings can be expected in the share price.
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Factors which cause stock volatility
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At different times, different stocks have been volatile. In the days leading up to the 1929 crash, all stocks were so volatile that the ticker tape could not keep up, and often prices were not updated for over 24 hours.
Today volatile stocks are usually small caps, where there are few shares traded and a sudden interest can create a large demand. This has the effect of driving volatility and the price up exponentially.
The explosion in the number of retail traders, has made even large caps share price move + or - 10% a day. Tesla stock in particular has seen its share price leap to incredible valuations due in part to the support of retail traders. Yet institutional traders continue to bet against it as they feel is an example of overvalued stocks. It is also affected by the tweets of its founder, Elon Musk. His infamous 'Funding secured' tweet was a volatility inducing statement.
For retail investors volatility is scary. Looking up your stock portfolio and seeing one of your investments down 20% is unpleasant. Although this is normal for a profit warning, if it is in relation to a piece of news which is not financially material, then you have just learnt something. That is why you should have the knowledge on why stock prices go up and down.
A stock which can increase or decrease by 20% on sentiment is volatile, and should be treated cautiously. Taking a position would be akin to momentum trading not investing. Tesla's meteoric rise this year and the difference in opinions, not to mention chart trading techniques being discussed is a case in point. Invest at your own peril.
Not all news is necessarily in the price.
Although the efficient market hypothesis states that all the information is priced into the stock, volatile moves would suggest it is not. Volatility increases as investors price in a breaking piece of news. The efficient market hypothesis dictates that finding undervalued stocks is impossible.
An investor will look to take advantage of volatility to buy in at a better price. Remember Price discovery is important. Saving a few percent every time you trade will compound over the course of a year.
For those who follow the buy and hold strategy, this is particularly useful. Indeed if a stock you are keen to own is incredibly volatile, why not give yourself a margin of safety? Rather than committing your entire budget immediately, maybe split your position size in three and buy in every time the shares increase/decrease by 10%. This way you average out your buy in price.
Although today's investors are focused on thematic investing with few seemingly 'checking under the bonnet', it is useful to understand what moves company profits by performing fundamental analysis. For gold producers this is the gold price. Fresnillo share price has proven to be somewhat volatile: up 50% since March 2020.
Fresnillo share price: 12 month view on the daily chart
This is because the gold price has increased substantially over the same period. Clearly if your key product is in demand, then you will increase your sales.
Gold price: 12 month view on the daily chart
There are other, technical reasons why stocks can become volatile. Many of the major stocks on the FTSE100 report their numbers in dollars. As a result they benefit when the dollar rises against the pound. This can lead to stocks becoming volatile if there are larges moves in the foreign exchange market. Companies such as Shell, BP and Astrazeneca are examples of dollar reporting companies.
One underlying factor which affects the volatility of some stocks will come as no surprise: the oil price! Major oil companies around the world are dependent on the price of oil for their profits. The crash in demand which occurs before a recession, often leads their share prices dropping substantially in a short period of time.
For someone looking to trade, the most volatile stocks are often attractive. They believe they can make a quick buck trading in and out. For an investor, a volatile stock can be a chance to buy in at a discounted price, if the earnings growth comes through over time.
Often volatile stocks are, by their very nature telling you something about themselves: they are risky. Whether you choose to place your capital at risk is a decision you should consider carefully.
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