A conversation with a fellow investor some time back got me thinking. The investor had placed a buy order for a United States (U.S.) listed counter shortly after the market opened, only to find that the price filled was higher than what was expected based on the previous session's closing price. There was no major news overnight, nor had the company announced anything significant. Naturally, the investor wondered what had happened.
As it turns out, this is not an uncommon phenomenon in the U.S. markets.
Picture generated by ChatGPT
If one were to observe the volatility of U.S. equities throughout a typical trading day, a pattern tends to emerge. Volatility is usually the highest during the opening period, gradually declines as the day progresses, and then picks up again near the market close. When plotted on a chart, the shape looks like the letter "U", hence the term "U-shaped trading day".
This observation is not unique to today's markets. Researchers have been studying intraday trading patterns for decades, and numerous studies have found that volatility and trading volume tend to be highest near the market open and close. The fact that this pattern has continued to appear across different market conditions implies that it is not merely a short-term anomaly, but rather a natural result of how investors and traders react to new information throughout the trading day.
The reason behind this is fairly intuitive. When the market opens, investors and traders are reacting to developments that occurred after the previous day's close. These could include earnings reports, economic data releases, geopolitical developments, etc. Since many market participants are trying to adjust their positions at the same time, price movements tend to be larger.
As the trading day progresses, much of this information gets absorbed into market prices. Activity typically slows down, resulting in lower volatility during the middle of the trading session. Towards the close, however, trading activity tends to increase once again as traders square off positions, market participants prepare for the next trading day, among other reasons.
For Singapore investors, this has some practical implications. The most volatile period of the U.S. trading day occurs shortly after the market opens, which corresponds to around 9:30 PM Singapore time (or 10:30 PM during Daylight Saving Time). Coincidentally, this is also the period when many local investors are most likely to be awake and actively monitoring the markets.
This means that those placing market orders during the opening period may occasionally experience larger-than-expected price movements. In such situations, limit orders may be more appropriate, particularly if one has already determined a reasonable valuation range for the counter being purchased.
It is also worth keeping an eye on major economic announcements such as inflation data, employment figures and central bank decisions. These events can significantly increase volatility, not just for individual counters but for the broader market as well.
The Bedokian's Take
The U-shaped trading day is an interesting market characteristic to be aware of, but for long-term investors, its significance should not be overstated.
A difference of a few cents in the purchase price may feel frustrating at the point of execution, but over an investment horizon measured in years or even decades, such differences are insignificant compared to the overall performance of the underlying fundamentals. The quality of the company, its growth prospects and the valuation paid remain far more important considerations.
Still, there is no harm in understanding how markets behave. Knowing that volatility tends to be elevated at the open allows investors to make more informed decisions when entering positions. At the very least, it may help avoid unnecessary surprises when an order gets filled at a price that is not expected.
Related post
Transact During Trading Hours Or Extended Hours?
Try out the Growth Indicator, Equities Indicator and S-REITs Indicator screening app for FREE. You can use it as a web page or save it as an app-like bookmark on your home screen of your computer, tablet or mobile for faster access.
No comments:
Post a Comment