Why overnight market moves are so misleading

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Wednesday’s resilient price action shows overnight traders don’t have a clue what they’re doing. The S&P 500 opened Wednesday’s session by gapping down nearly 1%. But those opening levels were as bad as it got and prices rallied nicely through the day. So much for all the death and destruction the futures market predicted a few hours earlier.

The problem with overnight markets is their thin volume allows them to be dominated by emotional retail traders. There is no way institutional investors can find the number of buyers and sellers they need to move their huge positions. That leaves basement dwellers and overseas speculators in control of a market they clearly don’t understand.

While these small traders can influence the open like they did Wednesday morning, when institutional investors show up for regular hours trade, they don’t give a hoot what overnight traders were doing. Instead, most of the time they go back to doing what they were doing the day before, which in this case was buying the bounce.

The best thing we can do if we find ourselves on the wrong side of an opening gap is to keep our cool. Often big overnight gaps reverse within hours. This is exactly what happened Wednesday when the daily low was within an hour of the open and the index rallied through the day, ultimately finished 1.5% above those early doom and gloom levels.

And this strategy isn’t just for protecting existing positions, if we have cash on hand, buy the early bounce with a stop under the early lows and enjoy the ride. If it doesn’t work out, no problem, get out near your entry point and wait for the next bounce.

As for what comes next for the market overall, always pay attention to how we close because how we open doesn’t count for squat. Wednesday was a nice close and even with the wind at their backs Wednesday morning, bears couldn’t extend the selloff. It definitely feels like we are running out of sellers at these levels and that is a recipe for a near-term bounce.

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