VOLATILITY  IS  YOUR  FRIEND™

AIM and Square Root Volatility (SRV)

Knowledgeable "AIMers" know that a good measure of volatility is necessary for a productive AIM account.   With typical investing methods, volatility is frequently looked upon as a "bad thing".   With AIM, volatility is a "good thing" -- Volatility is Your Friend.

Many AIMers who trade individual stocks screen for a high "Beta" in their selection process.   "Beta" is a common measure of volatility, measuring the relative movement of a stock as compared to stocks in general.

There is a simpler way to find higher volatility stocks; just look at lower priced stocks.   Lower priced stocks are more volatile (on a percentage basis, which is what we are interested in) than higher priced stocks.

Norman G. Fosback formalized and quantified this observation and called it "Square Root Volatility (SRV)" in his classic 1976 book   Stock Market Logic:  A Sophisticated Approach to Profits on Wall Street.

ADVANCING MARKET

Basically, as the market advances (or declines), all stocks change in price by adding (or subtracting) a constant amount to the square roots of their beginning prices.   For example, if the average priced stock advances from $25 to $36, that constant amount (C) is 1.   See Note 1

        C = SQRT(36) - SQRT(25)
        C = 6 - 5
        C = 1

Therefore, as shown in the table below:
a $1 stock should advance to $4
a $4 stock should advance to $9
a $25 stock should advance to $36
a $49 stock should advance to $64

NOTE 1:   The "constant amount" (C) comes out to be "1" in this example only.   It could be any amount, 0.8, 1.6, 2.4, 3.33333, etc., depending on the extent of the general market movement.
Round numbers were used in the examples for simplicity.

DECLINING MARKET

Here is a market decline example.   For example, if the average priced stock declines from $36 to $25, that constant amount (C) is -1.   See Note 2

        C = SQRT(25) - SQRT(36)
        C = 5 - 6
        C = -1

Therefore, as shown in the table below:
a $1 stock should decline to ... See Note 3
a $4 stock should decline to $1
a $9 stock should decline to $4
a $36 stock should decline to $25
a $64 stock should decline to $49

NOTE 2:   The "constant amount" (C) comes out to be "-1" in this example only.   It could be any amount, -0.8, -1.6, -2.4, -3.33333, etc., depending on the extent of the general market movement.
Round numbers were used in the examples for simplicity.

NOTE 3:   Yes, the SRV relationship breaks down in this case, as we don't expect the stock to go to zero.   This is a general rule of thumb, after all.

Look up Norman G. Fosback's outstanding book of stock market indicators and theories for details on SRV and other concepts of interest to the market trader or investor.  Here are three possible sources.
Stock Market Logic:  A Sophisticated Approach to Profits on Wall Street.
Stock Market Logic:  A Sophisticated Approach to Profits on Wall Street.
Stock Market Logic:  A Sophisticated Approach to Profits on Wall Street.

THE  AIM  "BIBLE"

If you would settle for getting rich steadily and surely (instead of trying for overnight and resulting in never), you need to read the book How to Make $1,000,000 in the Stock Market Automatically: (4th Edition) by Robert Lichello.   Don't let the "hokey" title put you off.   The book was first published in 1977 and is now in its Fourth Revised Edition (December 2001).   It's available on Amazon.com for about $7.00.   [2002-05-29] In this best-selling book, Lichello details his "Automatic Investment Management" (AIM) method.   AIM is perhaps the most popular and well-known Core Position Trading method with probably thousands of successful practitioners. For the basics of Robert Lichello's AIM methodology, see AIM Basics And, you may also contact me for consulting in addition to studying these web pages.

CONSULTING,  PROGRAMMING,  AND  SPREADSHEET
SETUP  SERVICES  AVAILABLE

If you would like assistance (consulting) with your Core Position Trading or AIM questions, refinements, and trading
contact me (David A. Bean)

NOTICE!

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This web page or others written by, hosted by, or linked to by David A. Bean are not to be construed as providing investment advice.  This material is provided for informational, amusement, and educational purposes only.  Consult a duly (dully) trained, authorized, credentialed, licensed, and brainwashed establishment professional before engaging in any financial transactions relying on this or any other information.