Wednesday, August 19, 2009

Persistence in Markets: Many Trends End Before They Become Friends

I've heard from several traders who lost considerable money early this morning, assuming that the overnight weakness would follow through to today's day session.

That raises an important trading question: what is the correlation between the changes that we see in the overnight market (yesterday's close to today's open) and in the day market (today's open to today's close)?

Since the start of 2009, that correlation has been only about .14 in the S&P 500 Index (SPY). That means that less than 2% of the variance in day time frame moves is accounted for by movement overnight.

We tend to see trends from one time period to another and assume continuity among markets. That assumption is worth challenging, however. Just because the market is moving one way during market hours in Asia or Europe doesn't necessarily mean that it will move that way once trade in the U.S. is under way.

With trading desks around the world keeping up with news, earnings, and economic reports, markets are increasingly global and increasingly efficient. By the time a move comes to our shores, it may be old news.