If you enjoy watching the stock tickers during the day, you know that a large amount of the daily volume occurs during the first and last hours of the trading day. In recent years traders have come to fear the last hour of the day because the market has moved hundreds of points in both directions during the three o’clock hour.
Along with higher volume comes higher volatility and traders have learned that they can use these times to their advantage but beware. If you’re an inexperienced trader, and most retail investors are, the best advice may be to avoid these volatile times.
Why the Volatility?
The Wall Street Journal asked the same question and did a study to find out. If you’re an active trader, you may come home from work, do some stock market research and place buy or sell orders that will execute at the open of the market the next morning.
You aren’t alone. Not only are you and millions of other retail investors doing this but hedge funds and other institutional clients do it as well. Second, day traders as well as high frequency trading systems have to set their positions for the day at the beginning of the day.
So how about the afternoon? Those who are purely day traders don’t hold positions overnight so they buy in the morning and sell at the end of the day ending with 100% cash. Although high frequency trading systems work in a variety of ways, many function as day traders selling close to the market close.
Index based ETFs have to balance their actual holdings with the inflows or outflows from the day as well as the traders who prefer to buy and sell for the following day so they avoid the pattern day trading rules.
Can You Profit?
You can’t profit over the long term so using any strategies that involves market timing down to the hour is extremely ill advised but there are ways to use the beginning and end of the day to your advantage.
Use Limit Orders
Value investors are always looking to purchase on sale. Because of the high amount of volatility found at the beginning and end of the day, you might be able to purchase the stock at an unbelievable price. Use a limit order with the levels set at an unusually low price and see if the market gives you a gift. It works more often than you would think.
Trade the Earnings
If a company is reporting earnings after the close of the markets, purchase at the end of the day in the hopes that the company’s stock rises significantly after hours. The next morning, you can sell your shares. Companies sometimes move 10% or more but they can go down as easily as they can go up. Understand that it is nearly impossible to play earnings with an educated guess so play it as a gamble. Use a put option to limit your downside.
Still, the best way to build wealth is through a long term approach but setting aside a small part of your portfolio for discretionary trading is a common practice among money managers. Some professional traders will not trade in the first or last hour of the day because of the artificial price action. If they find it too difficult to navigate perhaps retail investors should as well.