Every good investor knows that in order to make money on any investment, you must first understand all aspects of it, so let's look at why most trading volume is concentrated at the beginning and end of the day.
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If you have ever came home from work and used your evening hours to research stocks and place trade orders for the next day, you and others like you are the reason for the first hour high volume. As soon as the stock market opens, a rush of programmed trades enters the market and is quickly filled.
Along with the trades executed for retail investors, much of the volume comes from mutual funds, hedge funds and other high volume traders. Another source is day traders who have to set their positions for the day during the first hour. All of these factors added together represent a large amount of volume in a short amount of time.
But what about the afternoon?
A common rule among day traders is to always end their day without any stock positions, so they must sell their positions at the end of the day. Additionally, retail investors, trying to avoid day trading rules may purchase stock at the end of the day so they are free to sell it the next day if they wish. Some institutions often do not wish to hold large positions over long weekends or holidays when they have no means of liquidating should a big news event take place somewhere in the world.
So how can you profit from this phenomenon or at least avoid loss?
When you research a stock, look at the amount of volatility in the first and last hours of trading. If it tends to be very volatile during those hours, you may be able to buy or sell at a price which is much higher or lower than its fundamental value. Set your limit orders unusually high or low to see if you can catch a great bargain in the early minutes of trading.
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Use Limit Orders
You can safely trade during the first and last hours of the trading day if you stay disciplined, and the best way to do this is to use limit orders. A limit order allows you to set the maximum buy or sell price instead of buying or selling at the price the market will pay. If you own stock XYZ and don't want to sell for less than $34.00 per share, place a sell order with your broker and set your limit price at $34.00. The same strategy can be used when you buy a certain stock. (For more on limit orders, see Protect Yourself From Market Loss)
Trade Today for Tomorrow
Retail investors cannot buy and sell a stock on the same day any more than three times in a five business day period. This is known as the pattern day trader rule. Investors can avoid this rule by buying at the end of the day and selling the next day. Using this method, a person could hold a stock for less than 24 hours while avoiding day trading rules. Be aware that trading strategies of a short term nature come with a lot of risk, so careful research and risk management is imperative.
You purchased stock YZX for $30 today but you expect the stock to rise to $35 after they announce quarterly earnings after the close of the market today. This means that when the market opens tomorrow, YZX will open at $35 if you're correct. This creates a $5 gap in the chart which represents a $5 per share profit for you. (If you would like to know more about gap trading, read Playing The Gap.)
Whether or not you avoid these hours altogether or aim to confine your trading to these hours largely depends on your risk appetite and experience with the market. If you're a new or inexperienced investor, it is best to move carefully during these times.
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