As it turns, the notion I adopted in practice must have hit some other chart watchers, because the idea is also woven into a couple of technical indicators for “price channels.” The best-known indicator to use the two-times-ATR idea is the Keltner channel. And you can get those on stockcharts.com, too.

(In case you wondered: A Keltner channel is made of two bands around the price. The upper one is two times the ATR added to a 20-day moving average. The lower band is two times ATR subtracted from the moving average.)

Here’s something else for you. Watching ATR to gauge volatility can add to your market moxie: when a stock exceeds its own volatility habits—that is a two-day move of more than twice ATR—it tends to stop and go sideways. To show you this, I am going to give you another chart—this one with the ATR graph below it and the Keltner channel band shown around the price.

In this chart, the two-ATR days had a small overlap. As I said, it’s hard to find two consecutive days that move down by the whole ATR amount without any backtracking or overlap. But look at this Coca-Cola chart:

So you now have two tools you can use before you buy a stock to see what kind of volatility you are likely to get: the ATR and Keltner channels. Stockcharts offers both.

Of course, ATR changes over time, and when it is getting larger, the stock is becoming more volatile. It is probably getting into a stronger trend, too. But if you look at most stocks over a long period, they tend to stick within a limited range of ranges, so you can still get a good idea what you are in for. Even on the Coke chart, you can see that the stock doesn’t move up to a $3.00 ATR.

Some tools are for choosing good stocks. Volatility is not one of those, though it is sometimes misused that way (we’ll get to that when we get to the academics later on). It has nothing to do with the company’s quality or its earnings potential. But it will help you anticipate the range of normal movement to be sure you are choosing a stock you can stand to live with.

What We Take from This:

• This is about knowing what to expect from a stock, not picking the best one.
• To get a measure of what’s normal for a stock, look at its ATR on a chart. Assume that you will sometimes see the stock drop twice that amount in a couple of days.
• Two times ATR should be considered a routine zigzag, even when the stock is bullish overall. If that’s more adversity than you want to experience, don’t buy the stock.
• Stocks rarely drop more than two full ATRs over consecutive days without a rebound of at least a day or two, maybe longer.
• But when they do fall more than two ATRs in consecutive days, or hit the lower Keltner band, the stock will tend to go sideways a while.

Of course, a two-dollar a day move means something quite different on a $40 stock and an $8 stock. But that’s for next week in our volatility series.

Respectfully,

Lynn Carpenter

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