Tales of a Technician: Amazon and the Volatility Cycle
December 14, 2020
There are price cycles, and there are volatility cycles. Everyone knows the first one, but few pay attention to the second. Prices move from bull markets to bear markets, from motive waves to corrective waves.
Volatility, on the other hand, rotates from periods of expansion to periods of compression. Big moves are followed by small moves and vice versa. One common pattern you see during a compression is the symmetrical triangle. It’s formed by a series of lower pivot highs and higher pivot lows. When you connect them by drawing trendlines, it creates a triangle. The shrinking range reveals the compression.
Like a coiled spring, however, this pinching pattern builds momentum. Eventually, the stalemate breaks, and we get a big move in one direction or the other.
Take AMZN, for instance.
The e-Commerce King Sleeps
Amazon’s stock price is deader than a door nail. The pause is warranted, mind you, but it’s a bore nonetheless. As for the rationale for its rest, the global pandemic lit a fire under the stock sending it up 69% on the year. That’s enough gains to deserve as long a slumber as it wants.
But if the volatility cycle is any indication, this now sleepy stock will eventually wake up. And when it does, profits will come to those on the right side of the expansion.
Though the symmetrical triangle is a neutral pattern, it’s more likely that it breaks higher than lower. This is due to the longer-term bull trend which gives rising prices a tailwind.
Pick Your Poison
In situations like these, here are my preferred ways to time the entry.
- Anticipatory: Enter a bullish trade when you think an upside break is imminent.
- Reactive: Enter a bullish trade after AMZN stock breaks above resistance and confirms it’s exiting the triangle. In this instance, you might use $3,230 as your line in the sand. It’s the prior pivot high.
As for my strategy of choice for a stock like AMZN, I prefer OTM bull call spreads. They’re cheap and you can buy a few months out to give AMZN plenty of time to make a move.
For example, suppose I bought the Feb $3,390/$3,400 bull call vertical for $3. I’m risking $3 to make $7 if AMZN ramps to $3,400 by expiration.
You could widen the spread to increase the potential payout (and cost). Or, move further OTM or closer to the money until you get the preferred balance between risk, reward, and probability.
Regardless of the strikes or month used, I favor debit spreads in a situation like this because we’re looking for an explosive move. Credit spreads don’t capitalize on big moves as well.
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