Overnight vs Daytime Markets: Two Very Different Animals

30Sep10

I’m going to do a series of posts (inspired by Woodshedder ) on stock market performance in the daytime (open-to-close) vs overnight (close-to-open) sessions.

As weve shown previously. the overnight and daytime markets are very different animals, and understanding that difference is of uber-importance to active traders.

Since at least 1993, bull markets have tended to play out overnight and bear markets in the daytime.

[logarithmically-scaled, growth of $1]

To illustrate, the graph above shows two fictional traders.

The first (in green) goes long the SPY (S&P 500 ETF) at every close and sells at every open. In other words, our first trader is only long the market overnight.

The second (in red) goes long at every open and sells at every close. Our second trader is only long in the daytime.

This is a proof of concept so results do not account for slippage or transaction costs.

Clearly, bull markets of the last 18 years have mostly played out in the overnight session (green). The daytime session (red) has been about 65% more volatile, but generally speaking, bearish.

This observation continued to hold true in our most recent bear market. The following graph shows the same test starting in October, 2007.

[logarithmically-scaled, growth of $1]

The overnight session (green) has recovered to where it stood before the crises began, while the daytime session (red) is still nursing a 40%+ drawdown.

This observation has enormous implications to active traders when deciding when to enter/exit positions, and flies in the face of conventional wisdom about the dangers of holding positions overnight.

But that really isn’t what this series is about…

I want to expand further on Woodshedder’s post looking at how short-term mean-reversion (or the tendency for very recent price movement to reverse course) relates to the overnight and daytime sessions.

Apologies for the anti-climatic post. This was meant to be a primer for those who’ve never heard of the peculiar discrepancy between the overnight and daytime.

As always, more to follow.

Happy Trading,

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