Saturday, September 30, 2006

The S&P 500 Index and Its Multiple Personality

Here is the 2003-2006 bull market from three perspectives. The red line is the one we're most familiar with: it is the S&P 500 Index (SPY). The bullish and trending yellow line represents the cumulative price change of the S&P 500 Index outside of normal market hours (overnight). The blue line, which represents only a very modest gain over the entire period, is the cumulative price change of the S&P during the normal day session from open to close.

The correlation between the blue line (Daytrading Index) and yellow line (Nighttrading Index) is .04. What happens to the S&P during normal day hours is wholly independent of what happens to it after the close and before the open. The S&P truly has a multiple personality.

There are several implications to this breakdown:

1) Analyzing the Index as a whole (SPY) to derive patterns for daytraders may be faulty methodology. To the extent that researched patterns include--and are dominated by--overnight price changes, they portray opportunity that the daytrader would never realize;

2) Trend traders operating in the day timeframe would be well advised to extend their holding periods. Their trading methods might better take advantage of the trending component of the overnight market;

3) Because over half of all NYSE volume is program trading, the day session is dominated by arbitrage. Much of the market's directional activity occurs after the close and before the open, which is when many economic reports are released and when many influential world markets (currency, oil) are operating.

Notice that I am not saying that the day timeframe lacks opportunity. Rather, I'm suggesting that daytrading has not been offering a trending opportunity, and it is offering opportunity that is independent of what occurs in the market overnight.

To capture this opportunity, might it make sense to analyze patterns within the Daytrading Index, rather than in the S&P 500 Index itself? While the Daytrading Index is not a true trading index and traders are unlikely to replicate its performance by precisely buying the open and selling the close each day, analyses of historical patterns in the Daytrading Index would provide more accurate alerts to directional movements than analyses that include time periods during which the trader will never hold positions.

One other interesting implication of all this: With the advent of free trading, might it make sense for a trader to actually trade the Nighttrading Index as an instrument? Someone who bought the close and exited at the open each day would have done well, sans commissions, during the past several years.

I will be pursuing Daytrading and Nighttrading Index patterns in my own research and report here on this blog and in the Trading Psychology Weblog.


mdbllbr said...

I think the most of the overnight price change happens between 07:30 and 09:30 when important economic indicators are released. Can you check it? Perhaps you can use the price change of the sp future during the period.

When both index correlation is high it should indicate the strength of the main trend.

Brett Steenbarger, Ph.D. said...

Very good observation; thanks for the note. Simply looking at volume patterns from 7:30 - 9:30 AM ET compared to the rest of the overnight/pre-opening market suggests that this is a period when more price change is likely to occur. In that case, we have an example of market efficiency: the market is rather instantaneously adjusting to new information. What is interesting is that these adjustments are not then correlated with what happens in the regular trading session. They appear, on the whole, to be one-off shifts in market valuation.


Globetrader said...

instead of analyzing and trading an illiquid market overnight, you might eventually better take a look at indexes actively trading, when the bigger moves occur.

The indexes I would take a look at are:
For the Asian day session (5pm EST to midnight), the Australian SPI traded on SNFE and the NIKKEI, best traded in Singapure, as the commissions are cheaper.

For the European session, the Eurostoxx and the German DAX, which both trade from 2am EST to 4pm EST. After 9:30am EST they mirror the US markets and become illiquid after noon usually. Add to that the british FTSE and you have the markets most actively traded, when important premarket US news are released and where according to your research the big trend moves happen.


Brett Steenbarger, Ph.D. said...

Hi Chris,

You make an excellent point. For traders wishing to capitalize on the movement between the US close and open, there are many liquid indices available and traded electronically. Your suggestions are excellent.

The problem as I see it is that many daytraders in the U.S. markets--and this includes myself--extrapolate conclusions about the coming day's trade from daily data that may not be wholly relevant. I think this will be more readily apparent in my post tomorrow AM.

Thanks for your note and your excellent Globetrader blog.


oxbird said...

I cannot resist mentioning the idea that I have read in the past from those folks who believe in "PPT" Fed. Reserve interervention in equity markets....that frequently, odd spikes in the S&P futures occur in the early morning hours during periods where markets were weakening and at points of critical support. These spikes have been interpreted by some as being the result of intervention.

Is it possible that the difference in performance that you observe between daytime and nighttime S&P net price behavior is evidence of continual nocturnal intervention of this sort to support the S&P 500 Index?

I would have not considered such ideas as actually being possible in the past, but in the last few months, I have become more suspicious of our "free" markets and their oddball behavior.

Brett Steenbarger, Ph.D. said...

Hi Oxbird,

It would surprise me if a PPT operated on a daily basis, and it would especially surprise me if it operated in overnight markets. In the overnight, you'd have to see evidence of volume and, on a regular basis, that doesn't happen. The volume spikes that occur during the day, I strongly suspect, are related to program trading/arb.

I do think, however, that there are probably mechanisms in place to try to support price during prolonged or extreme declines. It would surprise me if those were frequent enough to affect trading patterns on a daily basis.


John Wheatcroft said...

But if I'm trading 4 minute bars my "trend" can last from 10 till 4 and be fairly substantial in effect.

Most daytraders are trading "stock" not "stocks" as is suggested by the term "market". And while the daytime "market" returns are not necessarily in tune with the overnight's, a given "stock's" returns can and often does surpass both.

I have traded overnight in the past and it works well but the risk is substantial. A terrorist event overnight in some foreign land or an unexpected interest rate rise in Japan can gap the market down severely the next morning and you can be stuck holding the bag. The skittishness of this market in general is enough to keep me flat and happy overnight - for now.

How about an article about volatility - it is crazy low recently while the market is crazy high and that usually portends evil this way comes.

Brett Steenbarger, Ph.D. said...


Yes, good point; individual stocks can trend within the day and provide good intraday returns. As a whole, stocks do not trend within the day. That is, if you buy X minute or X hour highs and sell X minute or X hour lows, you lose money. A screening and testing program such as Odds Maker can help identify stocks that do trend intraday. My experience is that these tend to be issues not commonly included in baskets of stocks for program trading.

Thanks for the volatility observation. I'll be posting something relevant to the Weblog tonight (


brettmm said...

I am wondering how the SPY actually mirrors the SP 500. Today for example the SPY low so far was 137.83 while the actual SP was lower at 1376.84 (SPY=137.68). Is there another SP 500 etf or other that is exactly traded at whatever the SP 500 is? Also, does any one have a link or know of one for the TRIN? I have a web based trading program (scottrade elite) and I can not find the charts or value of real time TRIN or an active/correct symbol. I tried $TRIN, TRIN.Z and TRIN, and none are coming up valid.

Brett Steenbarger, Ph.D. said...


Thanks for the question re: SPY and ES. Because of dividends and futures expiration/premium issues, they don't match up number to number, but do track each other well on a % change basis.