In this article I’m going to highlight a trading edge that appears in many different markets including both the futures and equity markets. It’s an edge that has persisted for well over two decades. This edge is a long bias that occurs in the “overnight” session as defined by the U.S. markets. Traders who hold long positions overnight can often be rewarded as substantial upward movement can occur during this quiet time. Does this edge still hold up? Or is it fading?
Many day traders discuss the advantages of closing out their positions at the end of the day. Such traders are often proud they don’t hold open positions overnight for fear of the market moving strongly against them in the overnight session. This is a valid way to trade, to be sure. There are clear benefits to day traders who close their positions at the end of the day. For example, if you’re a stock trader you are not exposed to a large gap which opens beyond your stop value thus, you may very well sleep more soundly. I have to admit there is some comfort knowing my account is flat at the end of the day. However, when it comes to market psychology what feels right is not often the best thing to do for your equity. What may appear to be a “safe thing to do” in reality, is more harmful than not. While this post is by no means a rant against people who close out their positions at the end of the day, it does get me wondering that this fear of holding through the overnight session may be worth investigating. I ask, does the overnight session hold more of a bullish or bearish edge?
Let me ask this question: When do you think the most points are accumulated in the S&P E-mini market: during the day session or during the overnight session? To answer this question I developed two simple strategies. Both strategies only go long. They both use a daily chart and a 200-period simple moving average (SMA) as a market environment filter so trades are only taken when price closes above the SMA. Both systems were executed from 1997 to September 2012 with no slippage or commission cost deducted.
The Day’s Session
The first strategy simply buys at the day’s open and closes the position at the end of the day. Thus, we are capturing the points gained or lost during the day session. The equity curve is a sum of the points gained or lost during the day session since 1997. Below is the equity curve of this trading system.
The Night Session
The night session strategy is just as simple but it opens a new position at the close of the daily bar. It then closes that position at the open of the next bar. Thus, we are capturing the points gained or lost during the night session. The equity curve is a sum of the points gained or lost during the night session since 1997. Below is the equity curve of this trading system.
As you can see there is a clear difference between the night session and the day session. What does this mean to you? There does seem to be an edge in exploiting long positions by riding the overnight session. My hypothesis is because so many active traders do not trade the overnight session, the market will often move in such a way as to lock them out from gains. Most people are familiar with the market shakeouts that rattle the faith of bullish participants, thus forcing them to lose their position. You’ve seen it where the market moves down to take out your stop only to reverse in your favor. A painful experience. However, the market does have another subtle trick that messes with your psychology. That trick is making you miss the bull move altogether. Put another way, not only does the market attempt to shake-out weak hands (stopping you out), it also does a fantastic job of leaving making many people miss a fantastic move (trapping you out).
However, is this edge fading? It just might be based on the equity curve. The last equity peek was May of 2011. In fact, since the year 2006 (just before trade number 1200) the equity graph has flattened out. This may be showing the overnight is beginning to lose its effectiveness. To get a better look at this let’s zoom in on the last five years.
If we look at the two equity graphs over the past five years we see the edge has reversed. The day session, while very choppy, is making new equity highs into September of 2012 while the equity high for the night session was back in May 2011. This indicates that for the S&P E-mini market the total points gained in the day session is more than the total points gained in the night session. Put another way the S&P E-mini market is now making noticeable gains in the day session while the night session is showing noticeable losses. So, is this trend reversing? Well, over the past few years, yes. However, I think we can’t say that yet for the longer term but we should keep an eye on it.