If the first and last hours of the trading day seem like the most hectic, it’s because they are. On a typical day, more shares trade hands in the first hour than during any other, as orders placed when the market was closed are processed. Volume tends to pick back up at the end of the day, as institutional investors look to close out positions or enter new ones.
Higher volume is generally good for active traders: More shares are available to trade, and that extra liquidity leads to tighter bid-ask spreads. But if you’re not careful, trades can quickly move against you, which is why most long-term investors should consider trading near the middle of the day, when conditions are generally calmer.
Even seasoned traders can find buying and selling near the bells a bit like surfing when waves are biggest—if you misread the conditions, you can easily get hurt. What’s more, the spikes in volume at these times happen for fundamentally different reasons, so strategies that help you successfully navigate the market’s open may work against you at its close.
After the opening bell
Higher volume doesn’t always mean higher volatility, because there can still be an equilibrium between buyers and sellers for a particular stock. But when news breaks after hours, an imbalance between buy and sell orders may cause a stock to open dramatically higher or lower than its price at the previous close.
Specifically, a stock with negative news often “gaps lower,” or opens much lower than it closed. In these cases, the stock tends to continue falling for the first five to 10 minutes as traders join the selling. This is typically followed by a recovery period for the next 20 minutes or so as the overnight gap is “filled” by the uptrend (unless the news pushing the stock lower is truly disastrous). If you’re long the stock, it may be best to wait to see it’s going to keep falling or start rallying. One way to protect yourself against further declines is to set a stop order under the lowest price reached in the first 10 minutes.
Stocks that “gap up,” on the other hand, may present a great selling opportunity. Like downward trends at the open, upward trends tend to reverse themselves after the first five to 10 minutes, so you’ll want to take advantage of the upside before the stock moves lower. In these situations, using a trailing stop that rises along with the stock may help maximize your selling price.
In either case, you should know by 10 a.m. ET whether the opening trend will hold or reverse itself. One clue is the strength of the trend line. If the line is steep—think 45 degrees or greater—then the trend is likely to continue. But if it’s relatively flat, there’s a greater likelihood that the trend will fizzle out.
Before the closing bell
While price trends can break either way in the opening hour, they tend to build consensus in the closing hour. Stocks that have been trending up typically keep rising, while stocks that have been tracking lower often plumb new depths.
This is largely because end-of-day trading tends to be dominated by institutional investors. Index-fund managers generally trade near the close in order to match the returns of their benchmark. And mutual funds typically wait to execute trades so they know how much cash they need to raise to cover the day’s redemptions or, conversely, how much cash from new inflows they have to invest.
Both of these factors tend to reinforce the direction prices have been heading over the course of the day. Indeed, if the market as a whole has been exhibiting a general uptrend, more often than not it will continue to move higher in the last hour. If you planned to sell a profitable position, this may be a good time to do it. You never know what news might hit after the close, and there’s always the potential for the stock to gap lower the next trading day. On the other hand, end of day is generally not a great time to add a position, even one with a clear positive trend.
Two caveats: Big news during the day—say, a Federal Reserve interest rate announcement—can upset these market tendencies. And when reversals do occur in the final hour, they tend to be severe. For example, if the market has been moving lower and then starts to recover, nervous traders may begin snapping up shares to close out their short positions in what is called a “short squeeze,” pushing prices dramatically higher. On the flip side, those with long positions may move to sell if prices that have been trending higher face resistance in the final minutes. Either way, it’s wise to wait until the last 10 to 15 minutes to determine whether the day’s trend will hold or reverse.
Reducing your exposure
Generally speaking, we believe traders should never use more than 5% of their account for a single trade. During the especially fitful opening and closing hours, it may make sense to lower that exposure to no more than 1%. And while there’s no guarantee that a stop order will be executed at or near the stop price, stop orders can help protect you against significant declines—especially when you’re not available to actively monitor your positions during trading hours.
Randy Frederick (@randyafrederick) is vice president of trading and derivatives at the Schwab Center for Financial Research.
Lee Bohl, CMT, is trading services manager at Charles Schwab & Co., Inc.