Trading conditions are currently very volatile. The FTSE-100 has been slammed by intra-day swings in excess of 100 points a number of times in recent days.
It is very difficult for long-term investors to invest in such volatile circumstances. Many choose to stand aside. But nimble short-term traders often profit during periods of high volatility.
Momentum Trading and Rebound Trading are two strategies that are frequently employed.
The basic principle driving successful momentum trading is to buy shares that are rising sharply on abnormally heavy volume.
Short-term momentum players often view any sign of slowing volume or a slowing rate of price appreciation as a sell signal.
Momentum trading makes sense for those who have good trading skills and are able to follow the ebbs and flows of the stock market constantly throughout the day. To succeed at this game, having sufficient time and the right personality are critical requirements.
My personal short-term trading preference veers in the opposite direction. Instead of searching for shares that are rapidly rising, I seek those with rebound potential in the aftermath of a big fall.
This can be a profitable short-term strategy if properly executed.
The main problem to avoid are Dead Cat Bounces, City-speak for shares that fall steeply, rally weakly and then resume their decline very shortly after you invest. The fact that a big drop has already occurred reduces the odds of a further big fall. But further falls are always possible and must be guarded against.
What I like about rebound trading is that research can be done calmly and thoroughly before any investment is made. Also, the procedure provides me with an obvious exit strategy. Any return to the most recent low is a pretty good warning that the expected rebound failed to materialise.
Here are three steps that help to make this short-term strategy work
A good starting point is to check the price trend over the last few years. Current prices should be near a level where previous declines ended. Chartists refer to this point as a "support area".
The second important issue to monitor is trading volume. There must be clear evidence of increased buying volume.
You should also carefully analyse the target company's problems. This step is more time consuming and judgemental.
The goal is to shy away from companies being slammed by a steady flow of bad news, with no end in sight. Look for companies whose shares have been slammed by problems that appear to have some end or solution in sight. It pays to read all available news releases from the last year or two to formulate an opinion. This web site is a good source to turn to. I also read comments from investor bulletin boards or chat rooms to learn what bothers private investors about the company.
Here is an example of how to play the rebound game using the price trend for Vanco, a designer and installer of telephone networks. I executed this trade a short time ago and have since closed my position so don't follow me. I use this trade merely to illustrate how to play the rebound game.
By way of background, Vanco was a high flyer from 2003 to 2006 but lost over three-quarters of its value in just 18 months.
Investor fears about dodgy accounting practices and high debt triggered much of this sell-off.
After reading all company announcements from the past year, I concluded that the company successfully addressed its accounting critics.
The most recent leg of Vanco's painful sell-off was triggered by statement made by the company a few months ago. Some investors interpreted the statement to mean that the company had accepted some unprofitable contracts merely to meet City sales expectations. The statement triggered another shake-out of weak holders, hopefully the final shake-out.
By mid-October, prices approached the low point last reached during the bear market of 2000-03. I elected to purchase Vanco shares once solid buying began to appear. As the chart shows, prices quickly gained one-third before stalling.
The big issue here is not the success or failure of a specific trade. In volatile periods, longer-term investors would be wise to either stand aside or focus upon short-term trading opportunities. If you choose to invest short-term, a systematic approach to evaluating risk, like the one outlined above, is worth thinking about.