Liquidity and Volatility | Podcast Episode #469

0:00
Hey everybody, this is Ryan Mallory with shareplanner.com Swing Trading the Stock Market. In today’s episode, we’re going to talk about liquidity and volatility and how they relate to each other and whether you should be choosing less liquidity for more volatility.

0:09
So this e-mail comes from a guy I called him Ocephus in the past. That was the name that I assigned people because I don’t use the real names in this podcast episode. I choose to give them a fake Florida redneck name so that their identities are concealed because you never know if they do or don’t. Don’t want to be associated with your show so I take that into the equation but Bocephus writes.

0:34
Hey Ryan, I have written you in the past and used the name Bocephus. I loved your podcast and really appreciate how forthcoming you are about being disciplined and setting rules for your trading. I am competitive bodybuilder and find that there is a lot of principles in bodybuilding that are similar to stock trading like discipline, learning to track your successes and failures, setting rules, limits, etcetera.

0:58
I have been learning about the stock market via courses and podcasts for the past year. After getting out of financial hardship, finally had the chance to open a brokerage account. I use your top down trading approach for selecting stocks and to use your parameters on market cap, volume, price etcetera.

1:14
I typically look at stocks with at least 500,000 to 750,000 shares of volume but typically more towards 1,000,000 so there is adequate liquidity to enter and exit a trade. My questions relate to liquidity and volatility of your stocks you are trading.

1:24
Do you feel that there is a balance to finding stocks with enough of liquidity but also have substantial volatility? Not sure if this question makes sense, but I have come across charts in my scans that have a high volume but typically only move 1% or less on a given day.

1:39
So it feels like that there is an opportunity to enter and exit but the stock is moving sideways more often than not. Any any insight or information would be great. Best wishes and God bless. Both Cephas.

1:55
OK, both Cephas. This is a good question. There’s a lot to actually talk about here because in this particular e-mail, he’s getting frustrated with the fact that he can’t find stocks that are giving him enough volatility, enough movement.

2:09
And we’re going to debunk some of those concerns that he has. First off, if you notice, he says that he’s he’s a bodybuilder, that he has to be very disciplined in his bodybuilding. As you can see, I’m not a bodybuilder, but but nonetheless, there’s a lot of carryover between bodybuilding and trading.

2:24
And that’s one of the things that I would encourage you is like, whatever your expertise is in the field, whether it’s construction, whether it’s bodybuilding or maybe it’s being a teacher, take the disciplines that those career fields have and learn how you can apply them to your trading.

2:40
In the case of bodybuilding, yeah, you got to track your successes. You got to look at your failures, and you got to try to figure out how you can get better. That discipline can carry over into stock trading, but it’s when we forget the disciplines that we use in everyday life.

2:54
And, and one of the fields that I noticed it the most in is in the medical field, Doctors in general, very disciplined people, engineers, very disciplined people until they get into the stock market and then they lose all sense of discipline.

3:02
I’m not saying that all of them are like that, but I would say a large majority of them are like that because then they start to rely on their smarts and, and, and sometimes maybe even egos to assume that just because that they’re, you know, in a very high level field in their profession that that’s going to carry over into trading.

3:22
It doesn’t market doesn’t care what what profession you you’re in. It does not care when NVIDIA gaps down. It’s not just gapping down for for the the non lawyers and the non doctors and the non engineers. It’s gapping down on everybody.

3:36
So you want to keep that in mind. Your profession can be a huge benefit to you if you take what makes you successful in one profession and carry that over into your trading, like the discipline, like tracking your successes, like risk management.

3:51
There’s a lot of fields that you have to practice risk management, Bring that over into your stock trade. So a little bit of a comment there that Bosephus made that wasn’t necessarily about the podcast itself or a question for the podcast, but wanted me to answer it anyways. Or at least I thought maybe he was wanting me to answer that.

4:11
But any case about the liquidity and volatility because I do think that there is a lot of good things to talk about here. 1 Liquidity issues in a stock that’s going to increase your volatility.

4:22
Why? It’s much easier for a stock to be manipulated or to move substantially if there’s not a lot of volume. And so liquidity issues are going to increase the volatility.

4:34
The price swings in the stock, if you don’t have a lot of volume, you’re going to have a wider bid ask price and that becomes a huge issue for getting good quality fills.

4:43
I mean, I’ve seen stocks that are like trading at $10 a share. They may only have like 20 or 30,000 shares being traded a day and they have a a bid ask of like 9:50 and 10:30. That’s a little bit too much for me.

4:59
I’ve, I mean, that’s a little bit of an exaggeration. I mean you don’t see that every time, but I’ve seen really wide stop losses, particularly when the market first opens and they’re trying to get the stock up and running.

5:07
You can have some really wide price present or if you’re hitting a a market order at the open, you may see like slippage of 3456 percent and you don’t want to be on the wrong side of that.

5:16
So no volume, you’re going to have an equal or is going, you’re going to have a larger bid ask there. And if you have no volume, that means that you’re going to have bigger moves because if they’re pinging off the bid in the ask price, you’re going to have much bigger swings, much more volatility.

5:47
And then those bigger swings are going to lead to making you have to have larger stop losses. And we don’t want that either larger stop losses that’s going to the cause you to have to take on much more risk.

5:55
And in order to have a good reward risk ratio, let’s say you’re using 10% stop losses on a very low liquidity stock.

6:03
Well then to justify the trade, you need a 20% move out of that stock. Could it do it? Sure. But to be able to consistently do that, I mean, you’re, you’re setting yourself up for, for failure.

6:18
If you start to get into a draw down, let’s say, let’s say you start getting to a losing streak where you have 5 losing trades that you get stopped out on. Well, then all of a sudden you got a combined net loss on those five trades at 50%. Not on your whole portfolio, but just on the last five trades. So if you’re putting, you know, let’s say 20% of your capital on a, on a given trade and you’re taking 10% losses. Well, that’s, that’s about, we’re talking about what, 2% of of your portfolio getting reduced each time you take on a losing trade, you have 5 losing trades in a row, all of a sudden you’re going to find yourself down 10% in your overall portfolio.

6:51
So that’s not good if you are looking at maybe taking a 3% stop loss or a 4% stop loss. A 5 trade losing streak is going to be radically different. And that’s the kind of mindset that you want to have. Drawdowns are brutal on the account and if you lose 10% in order to get back up to break even, you got to make 11% from where where you’re currently at or from off of your lows. And it gets even worse if you have a 50% drawdown in your account, you need to double your account or 100% to get back to break even.

7:23
So we want to avoid these crazy drawdowns. Whereas like if you have a 3% draw it on, I think it’s like 3.1 to get back to break even. That’s a huge difference even just from 10%. It’s, it’s a, it’s a essentially you’re, you’re having to make up much less ground. So keep the reward risk ratio in mind when you’re getting into these volatile, volatile stocks, because the ones that had the large bid asks ask and have low liquidity, they’re going to require a much bigger stop loss.

7:49
And if you find one, it’s like, well, there’s some really good consolidation here and it’s breaking out. I still think I could put my stop loss below that. If it’s got a large bid ask price, it’ll stop you out in a, in a blink of an eye. Even even if you do have a good chart in front of you, low liquidity is easily manipulated. One of the other things too, is that you, you open yourself up to, to massive gaps.

8:15
So if you look at some of the less liquid stocks out there, the one of the things that you’ll see on almost all the charts is there’s not a, a, a lot of times where it’s not significantly gapping higher or lower. And so if you find yourself on the wrong side of that, let’s say you’re long at $10 and all of a sudden it gets down to $8 and, and maybe even it comes back and hits, gets back to break even before the end of the day.

8:40
But if it gaps down to $8 and it stops you out, well, that kind of sucks. That’s not going to get you anywhere. You know what I mean? That that’s a brutal loss right there. And just because you had a stop loss at 4 or 5%, if it gaps down 20%, you’re not getting out for four or 5%. And I’ve seen that a lot more lately that people think just because they have a stop loss and that it’s going to be honoured there.

9:01
No, not if there’s nobody willing to, to buy your stock when it’s getting stopped out at that price. That’s why liquidity is important because you want to make sure that there’s going to be buyers to step in at, at that stop loss. And if you get a significant gap down or if a stock is susceptible to, to major gaps to the downside and you see a history of it, then that stop loss is going to be worthless if if it’s opening up 10–15% below it.

9:28
So all these things, I just want you to keep it in mind. I’m not saying that there’s never an instance where there, there’s not a trading strategy out there that can’t benefit from some of these stocks. But by and large, it’s a losing game.

9:40
So we know that the volatility equals bigger risk makes your trades a lot harder to manage to, like I said, with the gaps, but even just the day-to-day swings. And you got to think too about what does that do to your emotional health? When you’re seeing a stock move 5–6 percent, you know, you find yourself up 6%, you’re like, oh man, this is awesome. And then before you know it, by the end of the day, you’re down 1%.

10:01
And it’s so defeating when you see those, when you, when you experience those highs and lows during the course of a trading day, you really want to avoid that kind of emotional damage at all costs.

10:14
So what I want you to think about on trading, not about whether or not a stock is moving 1% or less during the day. That’s what technical analysis is for. The better you get a technical analysis when you, when you have like a, a tight coiling of where you get 1%, one percent, 1% days where it’s or less and it’s just not moving. There’s really no reason to be in it.

10:32
What you’re wanting to do is play a bounce or play a breakout. There’s really two major plays in swing trade breakouts and bounces. So it’s either bouncing off of the support or breaking through a resistance. You really don’t want a lot of that in between where it’s not really doing anything at all.

10:47
You want to make sure that it’s it’s coming off of a support level and you’re getting that continuation to the upside. That’s where following a big pull back, you can get a substantial bounce. Most of your gains, if you look at most of your charts takes place when there is a a significant bounce off of a key support level.

11:08
And likewise breakouts can lead to substantial improvements too. You look at meta, I mean, it’s on a what, a 13 day winning streak, the longest in its stocks history. And that came following a massive breakout of a triangle pattern, a continuation triangle. And so it’s continued to pile on the gains ever since that that breakout and it’s been able to do it in a substantial way.

11:25
But before that it was actually coiling. So you don’t want to really get in when a stock is just getting wound up tight. You want to get in when there’s a substantial move, whether it’s a break of resistance or a hold of support that leads to a bounce. Otherwise, you’re just kind of stuck in no man’s land.

11:41
You don’t want to be trading in no man’s land where there’s just nothing to really take advantage of. You’re just waiting for something to happen. And often times it’ll result in an outcome that you don’t really desire.

11:50
So keep the reward risk in mind. Also, what I want you to keep in mind is swingtradingthestockmarket.com Yes, that’ll take you to my share planner offerings. You can get to become part of the share planner trading block where you’ll be part of the where you get all my trades each and every day. Plus on top of that, you’ll get my daily watch list of the stocks that I’m looking to make trades for and I will send out videos each day for mega cap updates and and stock market updates. Overall, alternate those each day, plus each day you’re going to get a watch list review.

12:25
So I’m going to go over all the stocks that I covered that day in the watch list, let you know how they’re doing, what what you know, kind of actions I’m looking to take. Plus my bullish and bearish master watch list. Each week I send that all out on the trading block. It’s definitely worth checking out.

12:39
But again, bringing it back to reward risk, let’s say, let’s say for the sake of things in order to trade stocks that have liquidity, the only things that that move are only like in increments of 1%. Now I’m not saying that’s how it is in the stock market, but I’m just saying for example purposes, all the all the liquid stocks, they never really move more than 1%, OK?

13:00
But if you can still make 2 to 1 reward risk ratio, let’s say that your average stop loss is 1% and your average gain is 2%, meaning that if you get in the stock at $100 a share, you have a price target of about $102.00, a stop loss at $99.00 because the stocks don’t move that much.

13:26
Can you not do really well in the stock market if you’re constantly doubling the amount that you’re risking on every trade and you have at least like a 50% winning rate? Absolutely. You can do phenomenally well.

13:37
And, and the same can be said about whether it’s a six 6% average gain versus an average 3% loss. What you’re really trying to look for is making sure that your gains are out pacing your losses and not getting caught up on how much you’re making on an individual trade. It’s like, well, I want to make 15–20% on each one of my trades.

13:57
That’s great. But if you’re risking 13% to do it, that’s not nearly as good of a winning strategy as somebody who’s risking 5% to make 10% or 3% to make 6%. In fact, the 3% risking 3% to make 10% is way better than somebody who’s risking 14% to make 15%.

14:19
You’re dealing with a lot longer swings or a lot bigger swings in your trades and you’re staying in the stock for much longer than you need to because it takes a lot longer to get stopped out.

14:30
So in order to find out if you’re going to be a loser on the trade, you, and I’m not saying that derogatory or anything, but if you’re going to find out if it’s going to be a losing trade or not, you want to find out that relatively quickly. I don’t want to be stuck in a losing trade for months on end.

14:43
I want to lose fast win slow. I want to stay in my winning trades as long as possible. That’s great. I love it when I stay in a winning trade for more than a month.

14:51
I think that is like the hallmark of success because that means that stock has been running for me in my favor for a while. I’ve probably taken some profits along the way as well, but I’m letting that winner run.

14:56
But what I don’t like is when I start seeing a losing trade carrying on for like 2 weeks. Holy cow. I do not need that in my life because that just means I’m I’m tying up capital and something that’s losing me money. I’d rather lose that money fast and be able to deploy it into something else.

15:17
So focus on the reward to risk ratio, not on the the volatility of the trade. And you are correct, both Cephas. I try to say that without laughing, but Bosivas is right though.

15:29
There’s more volatility in stocks. When you’re trading stocks that are less liquid because the bid and ask price isn’t going to be that great, there’s less people that are interested.

15:42
And that’s another thing that I would highlight. Why? Why do these stocks? Why are these stocks illiquid? It’s because investors aren’t interested in them. The ones that they’re interested in.

15:49
Think about Apple. That’s a very liquid stock. Why? Because everybody’s interested in Apple. Same thing about NVIDIA or Microsoft, or if you can go down to like other stocks like Wayfair or Reddit, people are interested in those things.

16:02
But you can go into stocks that have like 6, you know, letter symbols to them and they, they trade, you know, 5 or 600 shares a day, man, you’re, you’re going in for a roller coaster there.

16:13
And a lot of people will trade those, a lot of people will trade without ever thinking about liquidity in a stock. That’s why in my scans I always have liquidity parameters. I don’t want to see anything that has low liquidity showing up in my scans and then fall back on technical analysis.

16:29
Just because there’s the liquidity in a stock or or or a good amount of liquidity doesn’t mean that it’s going to be a boring trade. The boring trades are really, in my opinions, the ones that tie up tie me up in a losing trade for an extended period of time.

16:42
If I have a runner that’s only going to make me ultimately like 10% over the course of a couple months, I’m fine with that. Why?

16:50
Because one, that’s a portion of my capital, but two, that that stock is running successfully to the upside and I’m managing my trade. When it finally starts to move against me, I’ll get out.

16:57
But I wouldn’t get caught up because also, I would say this, when you’re getting caught up on the volatility, you’re probably dollar watching. And dollar watching invokes emotions because you’re equating the dollars made or lost on a trade to something that’s important to you. And the market doesn’t care what’s important to you.

17:16
You’re equating it to your kids college tuition that you need to pay at the end of the month, or the mortgage that’s due at the 1st of the month. Or perhaps it’s a vacation that your wife or your husband is dying for you to book and you’re using and you’re trying to get that out of the market.

17:33
When you start to do that, you’re inserting emotions and variables into the market the market doesn’t care about. So don’t be dollar watching. Don’t be dollar watching at all.

17:42
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17:54
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18:02
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18:20
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18:28
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18:36
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18:53
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