Sunday, January 25, 2009

The Importance of the Market's Opening Price

The market's opening price represents an important synthesis of information, including the trading of overseas markets and the impact of pre-opening economic and earnings reports. Simply locating the open relative to the prior day's trading range provides meaningful information to the short-term trader.

Burning midnight oil this weekend, fueled by caffeine and club music, I reworked my proprietary system for calculating pivot and price target levels. The results were satisfying: 75% of all days touch the daily pivot level, which is an approximation of the average trading price for the prior day. The Resistance levels R1, R2, and R3 represent upside targets; the Support levels S1, S2, and S3 represent downside price targets for the current trading day. About 75% of all trading days touch either R1 or S1; 50% touch either R2 or S2; and 33% touch R3 or S3, based on backtesting to the year 2000. (Daily pivots will be posted each AM prior to the market open via Twitter. Most recent posts appear on the blog page; subscription via RSS is free).

Interestingly, when the S&P 500 Index (SPY) opens above its pivot level for the day, the odds of it hitting R1 have been 56%. When SPY opens below its pivot level, we hit R1 only 21% of the time. Conversely, when SPY opens below its daily pivot, we've hit S1 about 59% of the time. When SPY opens above its pivot, we hit S1 only about 19% of the time.

Once we have the pivot levels in place, many other historical patterns jump out, including how the prior day's volatility affects hitting price targets in today's session and how prior weakness or strength affects the odds of hitting price targets in the future. One of the more interesting patterns for study is time-of-day analysis: how the odds of hitting R2/S2 and R3/S3 are affected by the time of day that the market reaches R1/S1.

All of this is fuel for future research and future posts. Bring on the caffeine and music.