Directional trading almost always steals the show, but it’s volatility trading that captures the imagination. Viewing markets from a volatility perspective fosters new levels of understanding and, potentially, new opportunities. In today’s message, we’ll do just that, and we will offer up a few of the best stocks to buy before they break out!
The first thing to know about stock volatility is that it’s cyclical. Periods of compression are followed by expansion. Said another way, stocks rest and then run. It’s often a seamless cycle where resting gives way to running, which leads to yet more resting. The trick to volatility trading, then, is identifying situations where a sleepy stock is about to wake up.
Some view these as “coiled spring” stocks …
The apt description implies they have pent-up energy soon to be released in a strong directional move. Here are three such coiled spring stocks that may be the best stocks to watch.
Looking at the chart of Amazon (NASDAQ:AMZN) stock, it’s almost as if it downed an Ambien in early January and hasn’t completely shaken off the grogginess yet. This sleepy, sideways movement is quite uncharacteristic of a momentum stock, especially one as popular as AMZN … but it has created a textbook coiled spring pattern.
My favorite indicator for measure the degree of compression is the Bollinger Bands. These adaptive volatility envelopes expand and contract depending on the realized volatility of the underlying.
When the bandwidth narrows, it often suggests a big move is imminent. The nice thing about AMZN stock is the clear support and resistance zones that mark the outer limits of its range. $1715 and $1580 are the levels to watch. A break of either one should signal the direction of Amazon’s next move.
Traders can either wait for a break and then trade directionally or deploy long volatility trades, such as inverted flies or condors to bet on a large move higher or lower.
One bullish note about NFLX stock’s current posture is it still rests above its rising 20-day and 50-day moving averages. The basing near its high suggests an upside breakout is a more likely resolution to the recent stalemate.
With the upper and lower bands now only $17 apart, or less than 5% of the stock price, we’re seeing the tightest coiling of the past fourteen months.
While the sideways slithering could continue, it’s altogether more likely something shakes Netflix out of its stupor and it starts moving again.
Watch for a close outside of the upper or lower bands ($367 or $350) to signal the volatility surge has begun.
Goldman Sachs (GS)
Our final selection hails from the financial sector. Goldman Sachs (NYSE:GS) isn’t exactly known for its rousing momentum. But, even for a tame stock like GS, things have gone eerily quiet.
On the price front, the long-term trend is still bearish, but the intermediate term trend has turned bullish. Meanwhile, the short-term trend is neutral giving few signs as to who the eventual victor of these mixed signals will be. $203 marks the upper end of the range, and $190 marks the lower.
The width between bands has narrowed to its tightest range in a few years reflecting just how coiled this spring has become.
As with the previous two candidates, bi-directional trades look interesting here. If you’d prefer to bet on one direction, then wait for a breakout to confirm.
As of this writing, Tyler Craig didn’t hold a position in any of the aforementioned securities. Check out his recently released Bear Market Survival Guide to learn how to defend your portfolio against market volatility.