Tracking the last hour of trading

I recently pointed out in my research blog, TraderFeed, that the market's rise since 2005 has been different than it was during 2003 and 2004. In the early portion of the recent bull market, there was net buying during the last hour of trading. Since 2005, we have seen net selling in the final hour.

Some traders have contended that last hour trading reflects the actions of "smart money". Certainly it seems reasonable to assume that, if you're an institutional investor and strongly bullish or bearish on stocks, you're not going to want to wait for the next day's open to place your orders. This makes particular sense, given that much of the market's recent rise has occurred during overnight trading, not during the day session.

Below is a chart of the Dow Jones Industrial Average from January, 2002 to the present. Alongside the Dow (in red), I have created an index of the cumulative price changes attributable to the last hour of Dow trading. Both lines start at the same point in January, 2002, so we can see how they have behaved relative to one another.

What we can see is that the last hour traders have certainly acted like smart money so far. They were net buyers as the market made its complex bottoms in 2002-2003 and then were consistent buyers through the first portion of the bull market through 2004. Then, beginning very late in 2004, the last hour traders became net sellers, even during the Dow's recent rise and even more recent drop in the face of oil price strength, weakness in emerging markets, and Middle East uncertainty.

While such an indication, in itself, is not sufficient to predict an outright bear market, it does provide a yellow light of caution. Traders who couldn't wait until the morning to buy the market in 2002 and 2003 are finding reasons to not buy in 2006.

Brett N. Steenbarger, Ph.D. is Associate Clinical Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical University in Syracuse, NY and author of The Psychology of Trading (Wiley, 2003). As Director of Trader Development for Kingstree Trading, LLC in Chicago, he has mentored numerous professional traders and coordinated a training program for traders. An active trader of the stock indexes, Brett utilizes statistically-based pattern recognition for intraday trading. Brett does not offer commercial services to traders, but maintains an archive of articles and a trading blog at www.brettsteenbarger.com and a blog of market analytics at www.traderfeed.blogspot.com. His book, Enhancing Trader Performance, is due for publication this fall (Wiley).