Trading Near the Bells

If the first and last hours of the trading day seem like the most hectic, it's because they just might be. 

On a typical day in the market, the volume of shares traded, whether of individual stocks or index-tracking funds, tends to resemble a goblet: More shares trade hand early in the day; then the action often slows at midday; and then volume grows again near the end of the day. To be clear, this isn't always case and exceptions can occur at any time.

Higher volume is generally good for active traders: More shares are available to trade, and that extra liquidity leads to tighter bid-ask spreads (that is, the difference between the highest-price order someone is willing to place for a share, and the lowest-price order someone is willing to accept to sell one). 

Even seasoned traders can find buying and selling near the opening and closing bells a bit like surfing when waves are biggest—if they misread the conditions, they might get hurt. What's more, spikes in volume at these times tend to happen for fundamentally different reasons, so strategies that help you successfully navigate the market's open may work against you at its close.

A surge in volume at the start of the day doesn't necessarily mean prices become more volatile. Buyers and sellers can balance each other out, creating a kind of equilibrium. But when news breaks outside of trading hours, an imbalance between buy and sell orders may cause a stock to open dramatically higher or lower than its price at the previous close.

Stocks hit by negative news can "gap lower," and open at a price far below the prior day's close. A patient trader might look for a bounce from lows in the first hour, but if none occur early in the trading session, some traders might then choose to move on from the trade by selling their position.

Why might a bounce occur? Sometimes, a weak open can actually attract bargain-hunters, who might help push a stock upward from a temporary low. For example, an inflection point might occur around an area of technical support within a stock's longer-term trend. 

Trading in the market is about probabilities, not certainties. The takeaway might simply be that all stocks and traders are different, and it's important to have a plan to follow for all trades.

One way to potentially protect yourself against further declines is to set a stop order. Some traders consider placing a stop under the lowest price reached in the first 10 minutes. A stop order is an order to buy or sell a stock at the market price once the stock has traded at or through a specified price (the "stop price"). For a seller, if the stock falls to or through the stop order price, the order becomes a market order and is filled at the next available market price. Of course, with a market order, there is no guarantee of where the order will fill. 

Stocks that gap higher, on the other hand, may appear to some traders as a selling opportunity. As with any trend, reversals could come at any time, though traders tracking a stock that is moving higher on positive news might look for potential inflection points around the first hour after a big move. 

Those with a focus on the short term might consider placing a traditional stop order or a trailing stop order below their position to help protect their downside against a quick reversal. 

Conversely, a longer-term trader may choose to evaluate exit strategies over a longer timeframe, rather than worrying about intraday or short-term levels of potential support. As always, traders must know their timeframe for every trade.

In either case, traders should decide whether they believe the opening trend will hold or reverse itself. One clue might be the strength of the trend line. If the line is steep—think 45 degrees or greater—then they might decide the trend could continue. But if it's relatively flat, then some traders may believe the trend will fizzle out.

End-of-day trading can sometimes help solidify the consensus established by action earlier in the day. Stocks that have been trending up might keep rising, while stocks that have been tracking lower may plumb new depths.

This is largely because institutional investors may do a lot of trading late in the day. For example, index-fund managers generally trade near the close to match the returns of their benchmark. And mutual funds typically wait to execute trades so they know how much cash they need to raise to cover the day's redemptions or, conversely, how much cash from new inflows they have to invest.

If a trader planned to sell a profitable position, this may be their time to do it. You never know what news might hit after the close, and there's always the potential for the stock to gap lower the next trading day. On the other hand, end-of-day may not been seen as a great time to add a position, even one with a clear positive trend.

Two caveats: Big news during the day—say, a Federal Reserve interest rate announcement—can upset these market tendencies. And when reversals do occur in the final hour, they may be severe. For example, if the market has been moving lower and then starts to recover, traders who suspect a bottom may have been reached could decide to start snapping up shares—pushing prices dramatically higher. On the flip side, those with long positions may move to sell if prices that have been trending higher face resistance in the final minutes. 

Either way, the action in the final 10 to 15 minutes can help signal whether the day's trend will hold or reverse.

Generally speaking, limiting positions to a trader's preferred percentage of portfolio, no more than 10%, for example, can help manage exposure. However, during the especially fitful opening and closing hours, some traders are even more strict, limiting their trades to no more than 5% of their trading account. 

And while there's no guarantee that a stop order will be executed at or near the stop price, stop orders can help protect against significant declines—especially when you're not availabl5 to actively monitor your positions during trading hours. When traders have concerns about turbulent markets they may also lean toward limit orders instead of market orders. A limit order protects the trader from an unexpectedly low- or high-priced fill, though they also come with a  risk of the order not filling at all.