Tuesday, February 10, 2009

Understanding the Stock Market's Overnight Range

The previous post took a look at characteristics of non-trending, range days in the market; prior posts have examined uptrend days and downtrend days. Once you have an idea of the structure of a market day, you can plot a strategy for trading that day's market. That is essential for daytraders, but also aids longer time frame traders and portfolio managers in the execution of their ideas.

The overnight S&P emini market (ES futures) represents how value in the U.S. stock market is impacted by evening news events, overseas markets and news, and early morning economic reports. Is the overnight market trading within yesterday's value area (i.e., near yesterday's pivot price)? That suggests that events have not materially moved investors; often this leads to a quiet market open.

As a rule, the first price levels we'll test off the market's opening range will be the edges of the overnight range. A market that opens near the middle of its overnight range, moves lower, but cannot sustain a move below the lows of the overnight range is setting up a trade back into that range. In other words, we treat the overnight session as if it were a separate trading day unto itself. If the overnight market is trading within yesterday's regular session range, we look for a break above or below the overnight range to target a move to the prior session's highs or lows. Historically, 85% of all markets will *not* be an inside day; i.e., will pierce either their prior day's high or low.

Many worthwhile ideas about the day's structure can be derived from understanding the relationships among yesterday's range, the current day's overnight range, and the current day's opening price range--particularly when we place these in the context of volume, which represents the participation of large trading institutions. This will be the topic of upcoming posts.