Understanding The Market Requires You To Understand Market Psychology

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Understanding The Market Requires You To Understand Market Psychology

Stock market intraday patterns – all times are in Eastern Standard Time!

When day trading the US stock market you may notice certain patterns, based on the time of day, that occur more often than not. These patterns, or tendencies, happen often enough for professional day traders to base their trading around them.

9:30am: The stock market opens, and there is an initial push in one direction. Highly volatile!

9:45am: The initial push often sees a significant reversal or pullback. This is often just a short-term shift, and then the original trending direction re-asserts itself.

10:00am: If the trend that began at 9:30am is still happening, it will often be challenged around this time. This tends to be another time where there is a significant reversal or pullback.

11:15am-11:30am: The market is heading into lunch hour, and London is getting ready to close. This is when volatility will typically die out for a few hours, but often the daily high or low will be tested around this time. European traders will usually close out positions or accumulate a position before they finish for the day. Whether the highs or lows are tested or not, the markets tend to ‘drift’ for the next hour or more.

11:45am-1:30pm: This is lunch time in New York, plus a bit of a time buffer. Usually, this is the quietest time of the day, and often, day traders like to avoid it.

1:30pm-2:00pm: If the lunch hour was calm, then expect a breakout of the range established during lunch hour. Often, the market will try to move in the direction it was trading in before the lunch hour doldrums set in.

2:00pm-2:45pm: The close is getting closer, and many traders are trading with the trend thinking it will continue into close. That may happen, but expect some sharp reversals around this time, because on the flip side, man traders are quicker to take profits or move their trailing stop losses closer to the current price.

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3:00pm-3:30pm: These are big “Shake-out” points, in that they will force many traders out of their positions. If a reversal of the prior trend occurs around this time, then the price is likely to move very strongly in the opposite direction. Even if the prior trend does sustain itself through these periods, expect some quick and sizable counter-trend moves.

As a day trader, its best to be nimble and not get tied into one position or direction. Many traders only trade the first hour and the last hour of every day, as these times are the most volatile.

3:30pm-4:00pm: The market closes at 4pm. After that, the liquidity dries up in nearly all stocks and ETFs, except for the very active ones. It’s common to close all positions a minute or more before the closing bell, unless you have orders placed to close your position on a closing auction or “cross”.

Trade Entry Checklist – Things to Consider before entering a trade

1. Portfolio fit – Make sure you diversify your portfolio. If you have 9 open bullish positions, consider a bearish stance elsewhere to balance your portfolio and reduce risk.
2. Liquidity Check – If the stock you are considering has enough stocks traded per day. This can easily be found on Yahoo! Finance – look for “Average Volume.” Look for contract strikes that have at least 1,000 contracts of open interest – this minimizes bid/ask spread and ensures market liquidity so that you can actually enter/exit trades easily.
3. IV Percentile – Example: AAPL has IV of 45%, but IV percentile of 85%. This means that 85% of the time over the last year, volatility will be lower than it is right now as it’s current actual IV (45%). Likewise, if GOOG has an IV of 45% but an IV rank of 25%, then only 25% of the time over the last year IV was lower than it’s current value (45%). This means we have a 75% chance that IV will increase on average, meaning it’s current volatility is low – and we want to buy into that. If IV is between 70%-100% you will need to actively monitor that trade, higher risk.
4. Options strategy – Pretty straight forward- If IV is high and the price of the underlying is also high, we can eliminate bullish strategies and focus on bearish, and vice versa.
5. Strike Price – First you need to determine if you want an in the money (ITM) or out of the money (OTM). An ITM option has a greater sensitivity – delta – to the price of the underlying stock. So if the stock price increases by a given amount, the ITM call would gain more than an ATM or OTM call. This also means it would decline more than others if the price falls. ITM calls are more expensive as well – higher intrinsic value.

Next consideration is risk/reward. An ITM option carrier less risk, but costs more. If you only want to stake a small amount of capital in a trade, an OTM position may be your best choice. OTM positions are riskier, cheaper, and potentially much more profitable if the stock surges past your strike price.

1. Expiration – Date similarly to strike price, the further out a contracts expiration is, the higher the premium because time is on your side. There is a higher chance of the stock meeting your OTM target price given a year to do so, compared to a week. This is called Theta – a quantification of how much value is lost due to the passing of time. Theta also grows exponentially as you near the expiration date – your $190 strike call will be worth very little if the call expires tomorrow and the stock is at $180 because the probability of the stock reaching $190 is low.
2. Position size – This is important – BIG TRADING POSITIONS WILL EXPONENTIALLY INCREASE YOUR RISK OF BLOWING UP YOUR ACCOUNT. We suggest you place trades utilizing only 1-5% of your total account value, with an emphasis on the lower end. Play it safe, round down. It’s much easier to recover from a -5% loss than -80%.
3. Future moves – Think beyond what’s going on with a stock than just in the current day – unless youre scalping. Is there an earnings report coming up? Can I roll this into the next month if I need to? Is there an upcoming dividend payout? Take the time to plan your positions and don’t rush your entry – You want to ensure the best possibility of success. I’d take $500 profit with a 90% success rate over $750 profit with a 50% success rate any day. You want to build consistency, and plan your positions before you take them.

This is a write-up i did today to assist beginners AND experienced traders with understanding everything that needs to be understood in the markets. Enjoy!

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Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence or consult your financial professional before making any investment decision.