Friday, April 09, 2010

A Look at Price Changes During Day and Overnight Sessions in the Stock Market

It is natural to think of the day session in the S&P 500 Index (SPY) as an extension of overnight trading both in stock index futures and in the stock markets overseas. That is not the case, however. Since the start of the bull market in March, 2009, the correlation between overnight action in SPY (percentage change from yesterday's close to today's open) and day session action (percentage change from today's open to today's close) has only been .08. In a pure statistical sense, these are separate markets.

If we create indexes out of the price action of the day (pink line) and night (blue line) sessions, we can see this lack of correlation. Of the roughly 50 SPY points gained since the March, 2009 low, about 32 have occurred during the day session and 18 overnight. Note, however, that the day session price changes are much more volatile than the overnight series: during periods of strong rise and price correction, we've seen most of the changes occurring during the day session. Indeed, the standard deviation of price changes overnight is about 40% less than that occurring during the day.

What this tells us is that deciding whether to hold or not hold stocks overnight based upon what has happened during the day might be hazardous to traders' wealth. These are different markets, with different distributions of returns. While trading the day session only can eliminate the ambiguity of the overnight trade, it also truncates a significant portion of the bull market returns.