What you can learn from the first hour of trading

A reader recently wrote to me asking a research question. It seems as though a market commentator asserted that the S&P emini futures contract (ES) either makes its high for the day or its low during the first hour of trade on 71% of occasions. This struck my reader as a potentially useful piece of information, but he wondered if it is accurate. So I decided to look.

This is not the first time I've investigated the timing of daily highs and lows. Back in October, 2005 I wrote an article called "All Times of Day Are Not Created Equal" (available on the articles page of my website) in which I reviewed the prior 36 days of trading. Having read Mark Fisher's book "The Logical Trader", I wanted to see the odds of the market making its daily high or low during the first and last hour of trade. The results were interesting. I found that the daily high occurred during the first or last hour three-quarters of the time. The daily low occurred during the first or last hour approximately 60% of the time. Equally interesting, the midday hours only saw daily highs or lows approximately 10% of the time, although they accounted for one-third of time in the market.

The way I've used this information is to think in terms of "candidate daily highs and lows". When we sell off sharply in the first hour or run up significantly, I treat the high or low from that first hour as a candidate daily extreme. I then monitor the day's volume as we go along to estimate the market's likely range for the day. That gives me some clue as to how much the market might move away from this daily extreme. On the other hand, when we do make new highs or lows for the day during the midday hours, I make the assumption that these will not be the ultimate day's highs or lows. I then look for entries that will allow me to ride the trend into the final hour.

Of course, a 36 session sample is not much to go on. Prodded by my reader's inquiry, I went back to January, 2004 (N = 543 trading days) and examined the number of occasions in which the day's high or low was registered in the first hour. It turns out that we saw daily highs in the first hour on 177 occasions and daily lows in the first hour on 179 occasions. All in all, we saw either a daily high or low in the first hour about two-thirds of the time. It's not quite the 71% quoted by my reader's source, but it's not far from it.

So what can we do with this information? It seems to me that, if a market makes its high or low in the first hour, it is rejecting that high or low price as value. That rejection should manifest itself as significant selling or buying following the candidate high or low. Once we see the market hit a price extreme in the morning and then reject this with conviction, we now have the basis for a trade idea. The first retracement from the rejection move (i.e., the first bounce following a selloff from a candidate high or the first dip following a rally from a candidate low) should provide a relatively low risk entry for a short-term trend-following move.

A great deal of fruitful research could follow from this tendency. For instance, we could examine the early signs of rejection of candidate highs and lows so that these can be identified as quickly as possible. We can also examine the risk/reward of holding trades that reject first hour extremes until the final hour. Perhaps most intriguingly, we can explore whether this pattern plays itself out in individual equities and conduct real-time scans for signs of rejection of first-hour extremes to pursue this pattern among volatile stocks. It seems to me the Trade Ideas screening software should be ideal for such real-time inquiry. (Please note that I have no proprietary interest in this or any other market product or service). While historical patterns may not always play out in the present, this one seems particularly durable. Stay tuned.

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. He is currently writing a book on the topics of trader development and the enhancement of trader performance.