It is important for all stock traders to be aware of broad market tendencies, since they can have  a dramatic impact on individual stocks.  In fact, most of us who hold a large number of stocks intraday soon discover that you don’t actually have eight different positions… it’s more like one big one, tightly correlated to the S&P. As goes the market, so will go your basket of stocks more days than not, so it pays to understand the behavior of the broad market as well as you possibly can.

Today, I want to get you started thinking about some times of the trading day that tend to be inflection points.  A few of them are very obviously event-driven, but there are a couple others that don’t have a clear cause. I would encourage you to use this as a departure point for your own research, with one (serious) caution. If you are going to do research to try to understand how the market works, you need to look at A LOT of data. In fact, one of the newer traders probably still remembers the time I couple weeks ago when I bit his head off for his idle speculation that today “kind of reminded” him of a previous trading day. I was too harsh on him at the time, but my point was that any casual observation or anecdotal connection you draw is likely to do you more harm than good. The right way to do this is to sit down and go through at least a year of ES days, bar by five-minute bar, taking notes on each day. Yes, that is roughly 260 trading days, but the really bad news is that this is only a start! Really you need to look at several years, and if we’re honest about it, no one really develops market feel without living through at least a complete bull/bear cycle, which takes exposure to over a decade of price data.  You can dramatically shorten the learning curve by focused study, but above all, please avoid casual observations until you’ve really examined a lot of data (or lived through it firsthand.)

There is a high degree of random noise in the market, which makes any kind of analysis more difficult, but there also are some significant day trading patterns that occur with regularity. I’m not sure how to put this into blog form (and I’ve certainly been guilty of trying to write 1,500+ word blogs which has turned out to be too much for me to handle with regularity), but let me just start today with some high-level thoughts about the times of the trading day. I will probably expand on some of these ideas in a future post:

3AM (New York time): Yes, that’s right, 3AM. One reason we need to use futures and not SPY is that Europe actually trades our futures fairly actively when their markets open. Most major European markets open around 3AM so the first thing I look at in the morning is the price action around 3AM. This often sets a key inflection point for the day, as our futures will tend to lock into European market direction and follow them in our overnight session.

I will also look at the rest of the overnight for significant levels, but the key word is significant. If you have to really look and think about it, it’s not significant. If you see a level that is hit 6 times and holds with only a one-tick drop in the futures, that level just might be important later today, no?

8:30AM: sometimes an inflection point but purely driven by economic numbers. If no report, then this is probably not a significant time. There are releases at other times, but they have enough of an impact to make those typical inflection points. At any rate, this is a minor inflection point. (Note that pit sessions for US Bond futures open at 8:20AM. This used to be more of an inflection point, but I don’t see it so much in recent years.)

9:30AM: obvious inflection point and the study of patterns around the opening is a whole book in itself.

10:00AM: same as 8:30.  This has been an inflection point, but primarily because of the number of significant economic reports released around this time.

11:30AM: European markets close.  If our markets have staged a major reversal to the European session (eg. Europe was up overnight, we trade up on the open and then collapse into downtrend), this time of day can be very interesting as European traders scramble to cover a lot of their positions on their close. This is more of an influence than it was five years ago, but do not expect it to be significant if our markets are relatively quiet on the day. Also, this inflection can be a bit of a climax, temporarily capping the morning drive at exactly the point where naive traders are expecting the start of a major move.

12:00-1:30PM: Lunchtime. This is traditionally a dead time for the markets, and it continues to be true. Much less followthrough in broad indexes, and you really have to pick your spots. Depending on the kind of trading day (more on that later), we are on breakout watch near the end of this period.

2:00-2:45PM: Ideal breakout time. If the market has been rangebound, we are looking for a breakout to carry into close.  If that breakout comes much before 2:00, your thought should be “this is early, maybe too early to carry into the close.”  After 2:45, it’s getting a little late, but still possible. A breakout of a rangebound market that occurs in this timeframe deserves your respect–best to go with it or if you must fade, so so with the utmost care.

3:00-3:10: Countertrend inflection.  This used to be related to the bond pits closing (and maybe it still is), but if we are in a good trend there will often be a pretty dramatic countertrend inflection right around 3:00 PM.  This move will be big enough to shake out weak trend followers, so you need a plan.

3:00-Close: I follow a simple rule: Do not fade a last hour trend, especially if confirmed by NYSE ticks and multiple broad indexes. There is a lot of latitude for different day trading techniques, but I believe anyone looking to fade a strong last hour trend is making a critical mistake because some of the best market tendencies are for last hour followthrough. If you have been trading for a while and weren’t aware of that you probably need to re-think your market study process. At any rate, one of my very few hard and fast trading rules is “do not fade a last hour trend.”

4:00-4:15. This is a very interesting time when indexes are open, futures are open, but the cash market is closed. Sometimes you can see a real resolution of moves as pressure comes off the market and you get good trends in this time.  Be careful because many ETF products are not as liquid as you might think in this time.

That’s pretty much it… we do not (yet) see the kind of inflection points around the Asian opens that we do around Europe.

I hope this helps some of you begin a process for your own study of these time of day inflections. They are messy (not nearly as neat as this blog post leads you to believe), but they are very real, recurring influences that you must be aware of if you trade stocks or index products.

(If you do nothing else, pull up today’s SPY chart (8/23/10) and look at the turning points on that chart against this list of times of day. Interesting, huh?)