Thursday, March 11, 2010
The most important hour of the trading day is the first one.
The action in the S&P 500 during the first hour sets the tone for the day. Everyone on the floor of the exchange watches it. Traders in their offices filled with wall-to-wall computer monitors watch it. Computer programmers in the back rooms of Goldman Sachs and JPMorgan watch it.
Anyone who trades stocks intraday watches the first hour of action.
And you should too.
The high and low points in the S&P 500 during the first hour establish the "resistance" and "support" levels for day traders. Most of the time, stocks will either ping-pong back and forth between support and resistance for the rest of the day, or the index will bust out of that range and make a quick dash in the direction of the breakout.
For example, let's say the opening range for the S&P 500 is a low of 1,000 and a high of 1,010. After the first hour, the index starts pressing up against 1,010. Stocks will now either hit resistance and fall back toward the low end of the range... or they'll bust over the 1,010 level and gain a quick five or 10 points.
Either scenario gives day traders a quick opportunity for profit.
If stocks look poised to brea kout to the upside, then a trader can buy shares of a leveraged index fund and pocket a fast gain as the breakout unfolds. If it looks like the resistance line will hold, then traders can short that same leveraged index fund and profit as stocks drop back down toward support.
The obvious question is... "How do you know which way it'll go?"
That's where your indicators come in.
Every good trader uses a handful of technical indicators to help determine the strength or weakness of any move in the market. Of course, we don't all use the same indicators – which explains why some traders are bullish and others are bearish at the same time. Each trader has to figure out what works and then stick within those parameters.
Personally, when I'm day trading, I pay attention to just four signals. If the market is approaching resistance and all four signals are bullish, I'll look to buy stocks on the breakout and ride the market higher. On the other hand, if the signals are bearish as the S&P 500 approaches its first-hour high point, I'll take a bearish position and bet on stocks reversing back toward the support line.
It probably won't surprise you to learn one of the signals I watch is the action in the financial sector. I've referred to these stocks as "canaries in the coal mine." The banking sector usually leads the market. If the market is ready to make a move in one direction or the other, it'll often be telegraphed in the financial stocks first.
So, if the S&P 500 is approaching its first-hour resistance level and the financial stocks are up big on the day, the odds favor a breakout to the upside and I'll buy the market accordingly. On the other hand, if the financial sector is declining or lagging behind the market as the S&P approaches resistance, a bearish trade is more appropriate.
Of course, my confidence in any trade depends on how all four of my indicators are lining up. If everything is bullish, or everything is bearish, I'll take a larger position. If the indicators are mixed, however, it's usually best to trade small or not trade at all.
In yesterday's essay, I explained that many "day traders" are just gamblers by another name. But profitable day traders don't gamble. They find a way to recognize a temporary mispricing in the market and then capitalize on it.
A set of solid indicators is the best way to get clued in on those mispricings and tilt the odds in your favor. If you're just starting to put together your indicator "tool box," the first thing to do is watch the financials, which you can do easily with XLF, the big sector fund. Over time, you'll discover more indicators that work for you and your trading style.
Best regards and good trading,
Nasdaq hits 52-week high... tech index up 75% in the last year.
Pipeline stocks Kinder Morgan, Enbridge, and Energy Transfer reach new highs.
More spending stocks rally... department-store operators Macy's, Saks, Dillards make fresh highs.