Volatile markets generate lots of headlines and angst.
But volatility is a difficult thing to trade. It’s the favorite engine of day traders, who often make their money on the intraday buzz of the market. But the problem is that, by its very nature, volatility is unpredictable. In fact, among those day traders who love their fizzing stocks, some studies suggest that anywhere between 80 and 95 percent lose money.
So, how can you make volatility work in your own portfolio?
Real Money Columnist Paul Price has one approach.
“I wrote recently about Tractor Supply (TSCO), a company that was selling really cheap back in mid-2017," Price wrote on Real Money. "Back then, people were convinced that Amazon (AMZN) was going to put most brick and mortar retailers out of business."
Among those retailers "mall-based Williams-Sonoma (WSM) fell into that same mindset category. Earnings growth had slowed during both FY 2015 and 2016 even though each of those years set new all-time profit records… Interestingly, Value Line's end of fiscal year 2022 projected earnings per share for Williams-Sonoma was $5 even as of mid-2017. Now, just four years later, the firm posted EPS of $14.85 in FY 2021. That was almost triple what Value thought it might be 12 months later.”
Analysts get things wrong, Price argues. They can undervalue good stocks, and when that happens those stocks will usually fluctuate and often decline.
That’s when volatility can be your friend.
When you see a strong company with a weak stock price, that can be a signal that the market has missed its pricing opportunities. For whatever combination of reasons, other investors and analysts seem to have undervalued this company. In those cases you can buy the dip, confident that, as Price writes, “almost everything goes back to what it’s really worth.”
This isn’t a short term trading strategy. It can take time for good companies to return to their true valuation. But for investors with patience and some liquidity, it can be a very winning approach.
