Traders Ask: Why Don't You Trade Light Volume Stocks?

Hey Mike.

Hope you have had a great weekend.

In your book (In Play section) you mention you prefer the stock to do at least 1 million shares, and that you stay away from stocks where the daily volume is likely to be less than 600k shares.

The thing that makes me confused is that this makes no sense to me regards to your risk. Let me explain what Im thinking here, I might be off?

The value traded in a 600k shares per day stock is a huge difference if the stock costs 1 dollar compared to 100 dollar, and there for effects your buying power in that stock right?

Even though the volatility can be different in cheap or more expensive stock, the risk per tick might be the same if the spread is the same.

Say you buy 100 shares of the 1 dollar stock, and 100 shares of the 100 dollar stock. There is a big difference in buying power between those two buys, but if the spread is the same in those two stocks, your risk per tick is the same right?

So the question is really: Do you only look for a minimum of shares traded in a stock, or do you select stocks from daily value turnover as well?

Because there might be very little value traded in a very sheap stock, even though it trades 600k shares/day.

Bella Responds

Great question! I completely agree with your premise that for stocks with less volume you can control your risk with less size.

I use 600k shares of volume as my cutoff because of risk. In my experience when a stock has too little volume on an intraday basis I cannot control my risk. As a professional trader my first concern is controlling my risk. I want to find set ups where my upside is 5 and my downside is 1. When a stock has too little volume I have trouble controlling my risk. I cannot tell what my downside really is. I might think my downside is 30c, but with a stock of less volume, and less liquid I may learn my risk was really 60c. This is not good.

A few trading thoughts:

1. There are days when a stock with an average daily volume of less than 600k shares will do 3 million plus. Generally this is because of significant and fresh news. I will trade the stock on those days. We say it is In Play.

2. I do not trade stocks under $5, except on rare occasions. But I know a few traders who dominate in this space.

3. I do limit my tier size when I am a little unsure of my downside risk. So I might cut my tier size by 50-70 percent until I feel comfortable I can truly measure my risk.

4. There are traders who crush stocks everyday with very light volume. These are just not the stocks that make sense to me.

5. The issue is risk. It is not the fact that the stock does less than 600k daily, it is that I probably cannot control my risk. As a trader all I am trying to do is make excellent risk/reward decisions. If I cannot define my risk then I cannot make solid risk/reward calls.

6. Finally we measure the average daily range for our stocks before the open. If we are not optimistic that a stock will move intraday at least a few points then we search for a more active stock.

Those are some of my thoughts on dealing with low volume stocks. Perhaps they may help you develop your own rules. But in the end you must learn to make your trading system your own.

You can be better tomorrow than you are today!

Mike Bellafiore

One Good Trade

The PlayBook