Early trading often dictates what is likely to occur over the course of the session. This does not mean a trader can know exactly where the market will go, but rather the information provided near the open can help determine if the day is likely to be ranging, trending, sedate or volatile. By gathering certain types of information, a trader can better prepare themselves for the rest of the day.
Why the Open Matters
The open is the trader's first chance to get a look at what the trading day may hold (the pre-market also provides clues). Information from overnight and international markets is being absorbed and acted on by groups of traders as the markets head for the open. Investors have read news overnight and placed their orders with brokers. Professional traders are calculating how this will affect the first few minutes of the trading, and hedge fund and mutual fund traders are either actively involved or taking a back seat.
For day traders, the interaction of these groups provides valuable insight, which can aid them as the day progresses. Day traders need to watch:
- How much activity is taking place (who, how much and in which direction)
- If there is confidence in the move
- Where likely failure or surge points in price reside
Opening volume in the morning is always high compared to the rest of the day, generally only rivaled by closing volume. Therefore, morning volume compared to intra-day volume explains little, it must be compared to other opening volumes. Increased volume generally means increased volatility and a likely greater change in price. High volume in an index or stock early in the day indicates institutions are involved and there is a higher probability of daily sustainable trends. Low volume near the open of a stock indicates it is primarily short-term traders involved, and thus the daily climate is likely to be more of a ranging day.
To gain further insight, a trader may wish to filter volume by size. While small orders make up most of the trades on a stock, large orders account for most of the total volume. If the large orders sustain themselves in a particular direction, it is likely a sign of trending. Minimal large orders indicate more ranging movements. Large orders going through on both sides of the market indicates range bound short-term, but that a trending move (quite possibly aggressive) will ensue as one side conquers the other. (For related reading, see: How to Use Insider and Institutional Ownership.)
Gaps and International Markets
Traders may begin watching pre-market and see the indexes and stocks have already moved well away from the previous close on news or correlations with other markets.Some local and global markets are heavily traded prior to the official stock market open. Aggressive moves in these markets provide insight into what is possible as the stock market opens. Have stocks taken into account moves in gold, silver, bonds, oil, currencies and international stock markets? Did these markets have breakouts or severe declines? If so, it's highly likely you will see equities adjust according to their correlation with those markets. Little action overnight or in other markets indicates passivity and, unless something drastic occurs during the day, the trading day is likely to be dominated by range-bound environments.
Confirmation of Moves
A trader wants to be able to get some insight into whether an early market move is sustainable or if it is likely to tucker out, and there are many ways to help determine this. This will not only aid the trader in making trades on those moves, but it will also help in determining what the overall tone of the day is likely to be like. Some traders may look at $TICK, which is a measure of NYSE stocks trading at their offer minus the stocks trading at their bid price. It is a good gauge of the number of stocks participating in a move, and extremely short-term changes in sentiment.
Slightly less sensitive indicators traders can use are on-balance volume (OBV), Chaikin money flow or the money flow index. These indicators use slightly different calculations but help to determine if a price move has underlying strength. Aggressive moves off the open not accompanied by high volume, or confirming signals from the indicator(s), suggests an eventual a failure in the move. If the indicators are largely within former ranges, expect price movements to be constrained. (For related reading, see: How to Use the Chaikin Oscillator.)
The indicator's particular level is not important in this case, rather, it is how the indicator is acting relative to recent activity. Little change in the indicator(s), or a move in the opposite direction, with a big change in price, means a likely correction. If the price move is confirmed—that is, if indicators move with price—there is a better chance the move is sustainable and a trend has a higher probability of continuing.
Before the day even begins, a trader should draw support and resistance lines, including horizontal lines and trendlines (sloping). Has the stock or market been in a range lately or has it been trending? Are we near support and resistance? By drawing the support and resistance lines beforehand, a trader will have a better understanding of how the day is likely to unfold when trading begins. (For related reading, see: Support and Resistance Basics.)
If the market has been in a range and opens mid-range, more of the same can be expected. If the market opens near, or even above or below, resistance or support, then confirmations and volume become very important.
Plotting technical levels will also help throughout the day. As the levels are approached, traders can determine if other market factors are pointing towards a legitimate breakout or if the price will pull back from the level based on the aforementioned methods.
The Bottom Line
No one piece provides all the information we need, rather, all these elements work together to help us determine the type of day it is likely to be in the markets. By looking at international markets as well as other heavily traded commodity and asset classes, we can see if there already have been moves worth noting. The first few moments of trading provide a lot of information. If a trader analyzes that information closely, they will gain insight into whether the day is likely to flat or trending, volatile or sedate. (For further reading, see: Using Technical Indicators To Develop Trading Strategies.)