Volatility squeezes work both ways.

A very narrow trading range will often end with a bang. The stock just seems sleepy, meandering around in a little channel as if no one really cares about the shares.

Buyers are not so eager that they will push the price too high; nor are they too disciplined that they'll refrain from buying at current levels. At the same time, sellers are not so eager that they just start banging out bids indiscriminately; nor are they so stubborn that they hold out for higher prices.

The result is a lazy trading range that attracts little attention. But at some point, either the buyers or sellers wake up and become more aggressive.

Aggressive buying may push the stock higher than it has been in a while, thereby attracting more buyers. Alternatively, aggressive selling may start filling all the demand very quickly, prompting additional buyers to back away and wait for lower prices.

Either way, volatility increases, and those who are on the right side of the trade profit handsomely, while those who are on the wrong side of the trade sustain significant losses.

One stock that is just now pushing out of a volatility squeeze to the downside is Mattel ( MAT). Let's take a look.

Mattel has been trading sideways for the past couple of months, generally trending between $28 and $29. Such a prolonged bout of low volatility will lead to a volatility expansion -- the stock will move one way or the other in a big way. We just don't know the direction until it actually takes off.

Here, as you can see on the chart, on Wednesday the stock finally broke decisively below the 50-day moving average for the first time since last July. That's a big negative.

But even more telling is the environment in which the decline occurred. Both the Dow and the S&P 500 hit record highs yesterday, and Mattel fell more than 2.5%, closing at $27.68. Simply put, everybody was buying ... but nobody was buying Mattel.


Mattel (MAT) -- Daily


A prudent short entry would be at $27.60 or higher. Note that Mattel's intraday low yesterday was $27.62 -- if the stock gaps down at the open, it is likely to advance on short-covering. This advance would bring the stock back up into Wednesday's trading range, $28.37 to $27.62.

Once the short is opened, I'd consider putting a stop at around $28.70, which is just above the 50-day moving average. The downside target on this trade would be about $25.

Updates on Previous Picks

  • Assisted Living Concepts (ALC) remains on the Watch List. Right now, this short pick is still in congestion. Wait for a move up to $11.60, or a decline to $10.95 before shorting. Shares closed at $11.33 Wednesday.
  • Goldcorp (GG) is also on the Watch List. Wait for this short idea to snap back to $25 before entering a position. Shares closed at $22.81 Wednesday.
  • Last, Lam Research (LRCX) remains on the Watch List as well. Wait for an advance to $53.80 before shorting this one. The stock closed at $53.29 Wednesday.

At the time of publication, Fitzpatrick held no positions in the stocks mentioned, although holdings can change at any time.

Dan Fitzpatrick is the publisher of StockMarketMentor.com, an advisory newsletter and educational forum dedicated to teaching effective risk management and trading methodologies to aspiring traders and investors. He is a former hedge fund manager and a member of the Market Technicians Association, and he now trades from his home in San Diego, Calif. While Fitzpatrick holds various securities licenses, he does not give recommendations to buy or sell stocks. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. He appreciates your feedback; click here to send him an email.

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