Growth Stocks Bring Volatility, Potential For Large Rewards
Volatile stocks can be unnerving to investors, especially those trying their hand at growth stocks for the first time.
So when you invest, make sure you have conviction in the company and know it well. You can also figure out how volatile the stock tends to act before you buy.
Volatility can be measured by the beta ratio, which compares a stock's movements against the market over a one-year span. MarketSmith , an IBD sister firm, shows the beta for each company on its weekly chart.
Large, established companies like IBM (IBM) tend to have beta ratios below 1; they're less volatile than the S&P 500. However, smaller companies typically have beta ratios well above 1, indicating wider price swings.
IBD Leaderboard stock Palo Alto Networks (PANW)' beta ratio is 1.47, or 47% more volatile than the S&P 500 benchmark.
Growth stocks are usually much smaller and trade many fewer shares than their big-cap counterparts. As a result, institutional investors can cause huge gyrations in growth stocks by trading a relatively small number of shares.
How else can you gauge volatility? Look at a stock's weekly chart for swings of 10% or more, or by seeing how a stock behaves relative to its industry group.
Investors aware of IBD's strict buy and sell rules can harness the greater potential of growth stocks while minimizing the risk of getting burned.
Spirit Airlines (SAVE) has been among the biggest winners over the past year despite having a beta of 1.3.
The discount air carrier's latest base — a cup with handle — began taking shape in July 2013. The left side of the pattern shows two weekly declines of 12% and 16%. Volume was heavy each week, making the sharp declines even more jarring.
An investor who may have lacked the patience to wait for a proper base to form and simply decided to buy would likely have been shaken out of the stock.
However, trading tightened up as Spirit climbed the right side of the base. It offered a proper buy point of 35.26 — 10 cents above the peak of the handle — and broke out in strong volume during the week ended Oct. 11. After pulling back to its 10-week line 1, it climbed as much as 81% past the buy point to a record high of 63.89 on March 25.
High-growth stocks tend to be volatile because many are upstarts in their fields, offering new products or services that show great potential. Spirit Airlines disrupted the airline industry by offering ultra-cheap tickets while charging for everything from food and water to carry-on bags.
Strong sales and profit growth in the quarters leading up to the breakout attested to Spirit's success. Furthermore, the stock's Relative Strength line was hitting new highs as it soared above its buy point.
