Trading high volatility and low volume in today’s stock market should come with a warning, “Kids, don’t try this at home.” Certainly many hedge funds are currently sitting out the market volatile moves. The sorts of economic and political indicators that the people who manage over a trillion and a half dollars in assets watch seem a bit crazy these days. Although leaders at the Canada summit agreed to austerity measures it is uncertain how soon and how much and where such fiscal cutbacks will occur. The final shape of financial services regulations is not yet clear. Although Asia seems to be leading the world out of the recession the exact size and shape China’s future growth prospects is also unclear. The fact that hedge funds as a group lost nearly twenty percent of their invested capital just two months ago has taken the edge off of many traders’ zeal. The fact that folks are trading high volatility and low volume is a function of few traders willing to commit their funds to the market and the lower liquidity that goes with low volume. Technical analysis can be more risky when numbers are smaller making the pure technical traders wary.

Trading high volatility and low volume can be very profitable but it is the risk of substantial losses that is keeping many traders on the sidelines these days. Trading options with a strategy such as using straddles in the recovery market may be a better choice than trading stocks directly in high volatility and low volume. In a very volatile market a long straddle is a common means of profiting from excessive volatility when the market does not seem to know, or want to show, where it is going. The risk of a long straddle strategy is that if the underlying stock does not move in price then the trader will lose the price of two premiums. If, however, the market volatility takes the stock high or low the trader will profit by the difference between strike price and spot price minus the two premiums. Another, direct trading, strategy in trading high volatility and low volume is that many traders are only committing small amounts to their trades. The thinking seems to be that if they lose they will only lose on a small amount of capital invested. If they win with extreme volatility then the profits may be substantial compared to the amount invested.

In a more normal market traders focus on a sector, an event, or a trend. Trading the GM IPO and GM’s recovery, trading Toyota and the brake problem, trading banks in light of the pending regulatory changes, or trading freight movement in light of the recovery all could make sense in a more normal market. However, with such small volume and with big jumps in stock prices traders are “staying home” until the market direction and technical analysis make more sense. When trading volume goes up again it will because traders have a sense that the market has become predictable and it will likely come with better liquidity. When the only option of trading high volatility and low volume goes away the chance for extreme profits will go too but so will the likelihood for extreme losses.

More Resources

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