Defining The Stock Market Open
There are many traders that will avoid trading the stock market open because of the increase in volatility that is present during that time period. While it’s true that the institutional professionals are putting their money to work at that time with built up orders from clients as well as getting themselves and their firm positioned for the day, it still offers an opportunity for the individual trader as well.
The stock market open can be influenced by a few factors, and can be broken down into a few different segments. There are many opinions on what amount of time actually constitutes the stock market open. Some traders will say that the open is only just a few minutes, while others suggest it expands the entire first hour. For the purposes of this article, we will consider the stock market open to be the first 30 minutes of trading, which I have found to be the “sweet spot”. Please note that I am speaking about the US Stock market in this article.
The Gap Opening
The first piece of the stock market open puzzle is the gap. Almost every day, the stock market will gap, or open away from its previous close. This is due to emotional exuberance and the buildup of orders set to go when the market opens, as well as movement that took place in the pre-market time period. Most of the time, the gap is fueled by stock market news that is influencing the market overall (geopolitical, economic), or a key stock or sector that carry some weight in the indexes (Financials for example).
A common misconception is that all gaps are filled. This is NOT the case, and listening to those that preach how easy it is to make money just “fading the gaps” will lead you down a slippery road to blowing out your account. While fading, or going against the initial gap direction is the start of a viable strategy, there still needs to be more elements added in, as well as solid entry and management tactics. Usually, I like to wait for at least the first 5 minutes of the day to be in before looking to enter a gap fade, but there may be circumstances where I will get in early. These include a test and rejection of the extremes of the overnight range, or a major support or resistance level from the previous session.
There are also times when it is favorable to trade in the direction of the gap. If the fade is not working, I’ll look to reevaluate and consider another strategy. However, with the exception the presence of an opening drive (see below), I’m likely on the sidelines for the first half hour before going with the gap.
Charts courtesy of Tradestation
The Opening Drive
Borrowed from Auction Market Theory, the opening drive is a term used for a move that has a directional motive off the stock market open and within the first 30 minutes. If the market is just sloshing around and not gaining any directional traction, this suggests that a directional bias should be set aside, until an early consolidation forms that can be watched for a breakout move. If there is no opening drive present, my main strategy is to look to fade the gap.
However, if the market is moving with directional motive, it is something to pay attention to. An opening drive move can forecast an entire day’s action, and put you in the proper directional bias for the session very quickly. Look for rapid directional development with very little pause. While it’s dangerous to chase momentum, this doesn’t mean that the information is not useful. Look for the push to start to slow, and a continuation pattern to setup. Opening drives are a form of impulse, and therefore put us in continuation mode.
If the opening drive fails, i.e. moves out in one direction and then trades back through the opening, it can be a powerful reversal signal. When this occurs, it will trap those that were too aggressive and provide fuel for a trade in the opposite direction. When this occurs, it’s not necessarily a signal that a strong trend will occur in the new direction, just that the initial opening drive has lost its forecasting power.
After The First 30 Minutes
After the first 30 minutes are in for the day, the stock market open officially comes to a close for me. From there, depending on the model for the day as well as early action, there are different scenarios I will watch for and plan my strategies accordingly. I’ll touch on some of those in a future article.
While the stock market open can seem less orderly than other times of the day, this article should give you a good head start in analyzing who is making their move early on in the market session and allow you to plan accordingly.
Michael “tiny” Saul