The opening and closing periods of many markets are often the most important times in the trading day.
The opening of the market is the point at which new information, for example, overnight earnings or economic data releases, are priced into a market and the instruments within it.
The open is often one of the best points to assess sentiment and the dynamics of supply and demand. Particularly in markets where we have an opening auction or other standardised price formation process.
The importance of the opening period is underlined by the fact that in some markets there is a specific order type “market on open” for trading in at this key point of the business day.
However these days it's not just the open itself that is key to traders in setting the tone and direction of the day ahead.
The Importance of the First Hour of Trading
For short-term traders, the first hour of the trading day is one of the most important periods in the business day.
This opening hour can see significant volatility as traders position themselves from the off. The trends and levels established during this first hour often set the tone for the entire trading day.
By being aware of key levels and patterns during the initial 60 minutes, savvy short-term traders can gain an informational edge with which to identify emerging trends and provide them with references around support and resistance levels and gaps and or moving averages and metrics such as VWAP and the % of daily average traded in the first hour of business.
The Opening Range
Right at the market open, there is usually a surge of volatility as traders enter new positions for the day ahead. The high and low prices posted during this initial burst of activity form the “opening range.”
Watching how stock prices behave around the boundaries of this opening range can provide valuable clues into trader sentiment and which way the trend may be heading.
If the price bounces higher off the low end of the range, that may signal growing bullishness.
However, if a price rejects at the upper end of the range, that can tell us that the demand is not that strong and that we should be alert to possible reversal
Gap Analysis
Markets can often gap on the open that is trade at a price that is above or below the previous day's range. Gaps tell us that the market's opinion of a stock or another instrument has changed since the previous close. How large and how sustained the gap is can tell us a lot about what may come next in the price action
Source: Barchart.com
Tracking whether the opening prices have gapped up or down significantly from the previous days close is something worth doing
Price gaps often signify directional sentiment and can show the direction of overall momentum especially if it’s accompanied by volume.
Market wisdom says that gaps tend to get filled, so watch for that but that gap fill won't necessarily be on the same day and the longer they remain unfilled the stronger the move may be.
Testing the Theory in Practise
One way to test that hypothesis is to watch for instruments that gap up or down on the open, noting the size of the opening gaps and then tracking whether they move further in the direction of the gap, throughout say the first 20 minutes of trading.
The thinking here is that it is a much stronger signal if the stock or asset builds on the opening gap, rather than trading within it during early trade.
You can do this manually for a few names but if you want to examine a large group of stocks for example the members of an index or sector, then it may be easier to utilize a spreadsheet.
This is what I have done below:
Stocks that gapped higher from the open trigger a “True” response in column AH.
I also capture the size of the gap in pennies, and in price percentage terms. For example, Ticker PSH LN Pershing Square gapped up by 38p or 1.255% on the open.
However, it failed to hold on to those gains- which we can see in the Gap % Change Differential Column (AL) - which calculates the difference ( as a percentage of the current price), between the gap and the current change on the day.
In this list, the stock that gapped higher and continued to gain was paper and packaging group, Mondi. Ticker MNDI. Which added +1.50% on top of its +0.86% gap higher.
The fact that most stocks in this list, that gapped higher subsequently failed to hold on to those gains, and in many cases sold off sharply thereafter, is a signal in itself.
And one that suggests that sellers not buyers were in control of those stocks and perhaps the wider market.
This is just the sort of market intelligence that can provide traders with an informational edge one that can allow them to slant the odds of earning a profit (or worst case coming out for a small loss) from a trade in their favour.
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