You are holding a stock and it starts to increase in value. You decide to sell to take the profit but when you look back the stock has increased considerably in value. Had you only waited you would have made significantly more money. This has happened to all of us one time or another.
The ideal time that you should hold a stock depends on the stocks inherent volatility, generally for larger stocks you should hold for 6 months to a year. For smaller more volatile stocks you should hold for significantly less time; 1-3 months or less.
Today’s article is going to show you why holding for a set period of time is better than selling when you start making money. After reading this you should be armed with the proper knowledge to start making more money instantaneously in the market.
Let’s jump right in.
It’s All About the Stocks Implied Volatility
Every single stock on the market has an implied volatility associated with it. This IV (Implied Volatility) is a calculation that provides an educated guess on how fast a stock’s price can move.
C = SN (d1) – N (d2) Ke -rt
This is the calculation for implied volatility. Don’t worry you don’t need to perform this calculation for every single stock.
You simply need to understand the difference between a high IV stock and a low IV stock. The best way to guess the IV level of a stock is to look for the past chart history on the stock. If the stock’s price changes drastically over time then chances are its IV level is pretty high.
1 year chart on GME
The above image is a one year chart on GameStop. Notice how in late January of 2021 GME shot up from $30 to $500 in a week. This indicates that the IV on GME was huge.
Now here is a picture of the SPY.
1 year chart on SPY
Notice how the SPY does not have crazy price changes. Because of this the IV on the SPY is significantly less.
All you need to know right now is that a stock with a history of insane price swings either up or down typically indicates a high IV.
How IV Affects Holding Time on Stocks
A stock with a high IV typically is more prone to rapid price swings either up or down.
This poses a problem as every day that you hold onto the high IV stock the risk is greater that the stock will swing in price. These swings are largely unpredictable in nature and as such you can’t plan an investment around them. They just hurt your portfolio over time.
Below is an image of a high IV stock (GME for example)
As we can see from the above chart as IV increases on a stock so does your overall risk in the investment. Over time this is further exasperated so long as IV continues to increase.
As IV increases on a stock over time so does the total risk in your investment. On day 10 with an IV percentage of 150% you have just under a 100% risk value. This means that you should no longer be in the position as it’s too risky to continue to hold the position. Essentially over time your total risk in a position will increase to the point that no amount of potential gain can make the investment worth it.
This is the reason that high IV stocks should only be held for a short period of time. The longer you hold a high IV stock the greater the chance that you will lose money over time.
Now let’s look at a low IV stock (SPY for example)
As we can see over the same period of time the total risk in the ‘stable’ IV stock remains consistent at or near 10%. This is because the overall formula to calculate the risk multiplies over time, when IV is small there is little risk to compound.
Because the overall risk in the investment increases at such a lower rate on low IV stocks (SPY) you can hold them for a longer period of time without incurring significant risk in your portfolio. Likewise the higher IV stock results in significantly higher compounding risk values; which indicates that you should hold the high IV asset/stock for significantly less time.
So How Long Do You Hold Low IV and High IV Stocks to Gain Maximum Profit?
For Low IV stocks the ideal length of holding is between 6 months to a year before taking profit. This is because it’s harder to forecast earnings/sector longer than a year out for larger stocks/assets.
For high IV stocks the ideal length of holding time is 1 to 3 months or less. If the IV on the stock is huge in the 80-100% range then you should probably avoid investing in the stock, but if you must then only hold it for a couple days.
The reason you should hold these high IV stocks for less time is the effect of compounding risk over time. For most novice retail traders they completely disregard risk in favor of potentially high returns.
I’m not saying that there is no place for an investment in a high IV stock. I’m only demonstrating how you should hold the asset for a smaller time window depending on the current IV implied in the stock. If invested at the right time a high IV stock can return absolutely massive returns.
However, compounding risk overtime will silently kill your portfolio. Lower IV stocks generally don’t compound risk at a significant pace, and in some instances through dividends/distributions actually will lower risk (theoretically) over time.
This for example is one of the reasons that professional asset managers will opt for putting a majority of their clients funds during retirement into bond class assets. Over time the risk on these assets wont compound at a significant rate and will ‘guarantee’ their clients return.
This is why the running industry slogan right now is ‘risk adjusted returns.’
For larger stocks/assets with low IV the ideal length of time to hold a position is 6 months to a year. Likewise for smaller high IV stocks the best length of time is 1-3 months, unless the stock has an insanely high IV then I wouldn’t invest longer than a week.
By sticking to this and being aware of compounding risk you can position the odds of making money in your favor. Over time this can return absolutely massive amounts of capital and make you rich in a safe and efficient manner.
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Further, you should check out some of our other posts below!
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Until next time, I wish you the best of luck in your investment journey.