Learn Which Stocks Are Ready For Explosive Price Moves

Posted in: Investing
By J. Mark Soveign
May 17, 2009 - 12:39:02 AM

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On any given day, SOMETHING is moving higher or lower in the stock market worthy of putting money down on it, but how to do know what it is? You could be one of the traders that are making significant sums of money in the stock market, day in, day out. And all you need is the right information.

There are almost 10,000 different stocks that trade on all the different exchanges on the market. There are about 3.000 that trade on the NYSE, and another 3,000 on the NASDAQ. The rest of them are on the smaller exchanges and the so-called "pink sheets". So which ones do you choose to trade? Well in this article we are going to show you how to locate the really good stocks to trade.

One of my favorite stocks to trade is The CME Group (symbol: CME). It is a NYSE listed company that has a history of strong earnings. It also has a history of volatility. Volatile stocks are scary to trade, but without volatility there is not much chance of making money. Expert traders seek how highly volatile stocks because they know that at least they do move. There is nothing that is more frustrating for a trader to have a position on a stock that does not do anything, and the feeling gets worse when the overall market is moving and your stock is not.

As earlier stated The CME Group is a very volatile stock. It can move 10 or even 20 points or more in a trading session, and that is one of the reasons that I like it. If you are on the right side of the trade with CME and it is moving that day, you are making money. CME happens to be a very expensive stock. At the height of the bull market in 2007-08, that stock hit a high price of over $700 a share. It has subsequently traded below $200, and that is evidence enough of it's volatility. At the present time this stock is trading below $300 per share which is a lot of money. For this reason I choose to trade the options on this stock rather than the shares themselves as this requires far less trading capital needed to take a position. A detailed explanation of what a stock option is and why it is better is outside the scope of this article and will be covered in later articles but for the present time the reader should be satisfied to know that stock options are a means to deploy leverage so that very often a small amount of money can do the work of a large amount of money. In come cases options can give you leverage of 100 to 1, where one dollar does the work of one hundred dollars. The use of options can magnify your gains and losses very quickly. What this means is that you can very quickly make a lot of money by using a very small amount of money, and that is what traders are all about.

If you catch CME stock on the right day and at the right time, it can move 5, 10, 15, or more points in a few hours. This is fabulous action. It is for trader, whale territory. Most stock traders are content with stocks that move 1 or 2 points. They consider that adequate for their needs. In trader's parlance, one point is called 1 "stick". So, catching one stick is good action to most traders. With CME there is no one stick. There are 10 or more, or it all goes against you very very fast.

Momentum Trading

CME is a momentum stock. When it starts to move it tends to keep moving in that direction until something comes along and stops it. Stock price action that tends to accelerate across time is called momentum. Momentum is what you want to be riding when you are trading a stock like CME. The trick to trading momentum stocks is to hop on them just before they really start taking off, and I am going to show you how to do that right here. One of the very long-standing Wall Street traditions that have remained unchanged across the
generations is lunch. We know this to be true because the trading volume in the NYSE always tails off every trading day during the lunch hour. We can use this information to help us trade. Price momentum is almost always accompanied by high trading volume, and this makes sense. When a lot of people are ganging up on a trade one way or another, we expect it to move. So, knowing this we can time our entry into the stock to correspond with an anticipated increase in trading volume, and we can do this by placing our entry order to get executed just before the end of lunch which is 1:00 p.m. New York time.

If the stock market itself is having a good day, and CME stock is moving up in sympathy with the overall market, then we might consider buying the stock (or taking a bullish option position) just before the end of the lunch hour. It is at this time that we expect the overall market volume to be ticking up, and there should be a corresponding increase in trading volume of CME stock itself. If so, and the action has been to the upside all day so far, then the odds are in our favor if we are betting that the action is going to continue to the upside.

At this point it is important to understand that when the market is moving up sharply after lunch there is often a perception of the part of institutional investors that the market itself and many of its constituent stocks will close near the high of the day, and this creates a strong motivation for them to buy stocks before it gets too close to the close of trading.

About 25 percent of the entire day's trading volume on the NYSE is split between two time periods, and these are the first 30 minutes after the open, and the last 30 minutes before the close. So, a quarter of the entire days trading volume is squeezed into one hour, half of that one hour at the open, and the other half just before the close. When markets are moving sharply, volume and momentum tend to accelerate toward the close. This is true for all kinds of markets. Stocks, bonds, commodities, and yes, CME. You can take
advantage of this price action by timing your entry trades to take advantage of this increase in momentum.

Finding Other Good Stocks To Trade

It is very hard to make money on a stock that does not move at all. As a trader you need stocks that you take a position in to move, so in a nutshell what you are looking for is volatility.

One very important fact concerning all markets inexperienced traders are unaware of is that volatility is something that comes and goes. It ebbs and flows. It cycles in and out like the four seasons. Also, and this is important to remember, periods of high volatility are always followed by periods of low volatility, just like calm and stormy weather. This is true of all markets, and knowing this puts the odds in your favor provided you only get involved in a situation where you expect volatility to increase. Happily, volatility is something that we can measure. So if we do measure it, then we can tell if it is a good time to get involved in a momentum stock, or a bad time. It is good to buy high momentum stocks after they languish in a long period of low volatility. We can measure volatility by using a standard volatility indicator.

The Bollinger Bands

Any decent stock charting platform will offer you standard indicators. The very best and simplest to use volatility indicator is the Bollinger Bands indicator. Bollinger bands measure recent stock market volatility. The indicator consists of two bands that straddle the stock price on the chart. When volatility is high the bands widen and move apart. When volatility decreases the bands narrow and move together. When considering trading a stock first measure it's volatility. If the stock has shown evidence of recent volatility, then you have to think that you might be getting in a little late. If the stock has shown evidence that it has been in a long protracted period of low volatility, then it might be setting up for a big move in the near future!

Bollinger Bands showing low volatility

Remember, periods of high volatility are always followed by periods of low volatility, so by measuring the currently volatility of the stock, you are giving your self better ads of positive outcome. Make it a rule to only buy the stock after you notice it has lingered in a long period of consolidation or sideways action.