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Overnight trading: Stock Markets, Apparently, Only Make Money At Night

By Tim Worstall

13:28, 15 July 2022

Tim Worstall, senior fellow of the Adam Smith Institute and former metals trader
Overnight trading: Business and economics writer Tim Worstall, senior fellow of the Adam Smith Institute and former metals trader

There's a weird theory out there, that stock markets don't in fact make money when they're open. It's only when they're closed that prices move enough for us investors to be able to cash in. The obvious reaction, if this is true, is for us to be trading the S&P 500 (US500) overnight. Or possibly the mini-futures, or something like an S&P 500 ETF. The specific instrument used will depend upon risk appetite, trading costs, size of position and so on.

S&P 500 (US500)

Of course, it's necessary to work out whether the claim is true before anyone starts to try trading it and there's the little difficulty. For we've a pattern observed, but it's not been observed for very long and we're not sure if it will persist. This is also what is known as “time arbitrage”. We've talked about arbitrage before, that depending upon the idea that things are fungible. This time arbitrage idea is different, in that we're not buying and selling at the same time to lock in a profit. Rather, we've a pattern that seems to replicate over time, so we can ride that pattern through time. Or, the other word for this is speculation.


So, the claim is that the S&P 500 rises over time, sure it does. Part of that is that the economy has been growing over time so obviously so will the value of the large companies. Also, stock market indices are not revalued for inflation – so that decline in the value of money over time does always make the DJA, S&P, FTSE100, rise over long periods of time. It's also true that we've just had a decades long rise in the stock markets, the mirror image of the decades long decline in real interest rates. Bonds are worth more when interest rates are high, stocks when they're low, that's just the way it works.

 

The observation is that if you pull out the change in the S&P 500 into day time – when the markets are fully open – and nighttime – which includes postmarket and premarket trading – then all the rise in the index happens at night. One recent estimation is that the rise intraday is around zero, that overnight about 1000% since 1990 or so. That's on the SPDR S&P 500 ETF.

Well, it is possible to simply trade patterns like that. That's what much high frequency trading and algorithmic is. Patterns exist, no one – not even the AI – knows why, they just trade them until they stop making money then they stop trading the pattern. We might want to make a little more effort to work out why a pattern is happening for after all, we're not a hedge fund playing with other peoples' money.

The problem is no one does know why this pattern exists. One entirely serious idea – based on the Vanguard S&P 500 futures - is simply that Americans don't know what prices should be. So they need Europeans, when they wake up (that 2 am to 4 am US time period) to tell them what they should be. Attractive as this idea is, that we cultured types have to tell them, there's a certain lack of proof. Observation, yes, but not proof. The Federal Reserve is sure that it's the additions of 24 hour futures trading to the system that is the reason, but again exactly and precisely why, well, shrug? They are right by the way, the big structural change is indeed that futures now trade 24/7, meaning that stock markets themselves, well, they're not the only price action in town.

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Vanguard S&P 500

Another – and very boring – answer is that stock markets are closed for more of this new 24 hour trading period than they are open so of course more of the price action happens when the stock markets are closed. Oof, now how interesting is that, just arguing about the number of hours in the day?   

US100

18,549.60 Price
+0.010% 1D Chg, %
Long position overnight fee -0.0262%
Short position overnight fee 0.0040%
Overnight fee time 21:00 (UTC)
Spread 7.0

US30

39,997.70 Price
+0.340% 1D Chg, %
Long position overnight fee -0.0262%
Short position overnight fee 0.0040%
Overnight fee time 21:00 (UTC)
Spread 11.0

HK50

19,724.90 Price
+0.790% 1D Chg, %
Long position overnight fee -0.0225%
Short position overnight fee 0.0005%
Overnight fee time 21:00 (UTC)
Spread 30.0

DE40

18,731.50 Price
+0.240% 1D Chg, %
Long position overnight fee -0.0221%
Short position overnight fee -0.0001%
Overnight fee time 21:00 (UTC)
Spread 8.0

A truly interesting argument – really, very fun – is that big hedgies are conducting a massive pump and dump. In thin markets an individual buyer can drive prices up precisely because the trade is thin. That's the pump part but the problem is always that in a thin market the dump drives prices back down again and no money is made overall. But if the pump is done in the overnight market, liquidated in the more liquid daytime market then it could – could! - work. Opinions on that are, as we might say, undecided.  

It is, finally and most boringly, possible to go back to the beginning of the academic note of this oddity and think about what was originally said. For this was noted back when overnight trading first became a reality, in the early 1990s. Prices rise after the markets close, before they open, now why the hell is that

This boring answer is that most price moving news happens out of hours. Therefore market prices move more out of hours than within them. There's something almost obvious about this. If you monitor the news service of the London Stock Market, for example, then most announcements happen between 7 am, when the service opens, and 8 when the market does. The corresponding information flood for the US markets generally – not always, but generally – happens after market close at 4 pm.

So, the reason why markets move outside opening hours is because the information that moves market prices arrives out of hours. And, well, hunh, ain't that a shocker? 

Now, how trading strategies get designed given all these alternatives is up to those doing the trading. The observation itself, markets move more out of hours than within them, is true. But the why matters as to how a strategy to trade the whole market depends upon which explanation rings true.

The one and only fully true lesson to take from this academic observation is that day trading isn't quite the thing. Evening trading might, be, morning trading possibly, but only in the day when the markets are fully open is missing much of the price change that makes trading potentially profitable.

Markets in this article

IVV
iShares Core S&P 500 ETF
532.20 USD
0.85 +0.160%
US500
US 500
5305.7 USD
12.1 +0.230%
VOO
Vanguard S&P 500 ETF
486.72 USD
0.73 +0.150%

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