With the markets acting the way they have for the last two years, there is no shortage of investment analysts ready to give you their opinion. It's hard to watch the television and not hear varying opinion about how, exactly, you should proceed in this "volatile" market. Much of the advice is to invest in low volatility stocks and avoid high volatility at all costs.

If you have your money in the markets as opposed to a savings account, you are probably trying to make more money than the bank will give you for it. But to make money in the markets, you NEED volatility. Without it, you won't lose any money, but if prices don't move you'll never make anything either. It's like trying to become a professional swimmer while never touching the water due to the fear of drowning. Prices need to move for a gain to be accomplished, so don't try to avoid price movements.

BUT, there is a way to use low volatility conditions in volatile stocks to reap the rewards that volatility has to offer. Since volatility moves in cycles, low volatility moments can be a great entry point for a short-term, and sometimes even a medium-term trade. An extreme low volatility position showing minimal price movement typically will follow its volatility cycle into a burst of high volatility, or a sudden movement of prices.

To give an example, the everlasting Microsoft will be used.

In this image, Microsoft is shown for the last four years along with its 21-period historical volatility. The points that are marked are all of the times that the historical volatility has moved below 30.

Here is the first point on the chart where a below 30 point is reached. On 6/15/98, the volatility reading goes down to 29.71, a relatively low volatility for Microsoft. Starting the next day, the stock moves out of its low volatility range (by our subjective placement of 30) and in just one month makes an almost linear 15 point upward move.

The second point on the chart shows the volatility reading at 29.94 on 11/20/98. The low volatility breakout then proceeds to move up (again in a fairly smooth movement) just over 30 points in less than two and a half months.

Third, there are two points marked. The first occurred on 5/27/99 with a volatility level of 29.20. The breakout took the stock into a 20 point move in slightly less then two months, though not as smoothly as the other two did.

The next mark shows where the volatility didn't quite hit 30, only reaching down to 31.08. While this mark did not meet the specified criteria for volatility, the next 4 days of the breakout moved over 10 points. Unfortunately, the position would not have been takes by the rules specified (not reaching the level of 30).

The fifth mark appears on 11/18/99 at a level of 26.77. This one then proceeds to move almost 35 points in just a month and a half! And it moved fairly smoothly with little adverse activity.

The sixth mark poses an interesting note about the volatility breakout. A high volatility move can occur in either direction. In this case, the low volatility point first occurred on 8/31/00 at a level of 29.96. From this, to really take any low volatility advantage, an analysis of the breakout direction should be considered. This is usually accomplished by placing two entry stop orders simultaneously; one for an enter long position at some value above the low-volatility price on the chart, and a second for an enter short position at some value below the low-volatility price on the chart (if you want to take advantage of short side trading positions). In this case, the enter short stop order would have been executed and the enter long stop order would have never been hit. If the short had been taken, the price would have move down 20 points (most likely being stopped out with a trailing stop when the upward gap occurred resulting in only 8 points really being kept, but still a profitable trade).

The last two marks occurred on 5/21/01 and on 6/25/01. Since both marks would have technically signaled an upward move, both of these would have resulted in 3 to 4 point moves at best, but realistically would have been breakeven moves, or even slight losses. Note that the real volatility expansion ultimately turned into a 15 point downward move, but there really were no rules we had established that would have signaled to hop on board that particular move.

While not every move was exactly profitable, the collected profits would have significantly outweighed the losses that would have occurred, even if taking only long only positions.

It is interesting to note that as of the day of writing this article (1/15/02), a low volatility mark has been hit (29.44). It should prove entertaining to see what develops from this.