Uncle John's Cabin

A Day in the Life of a Market

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I don't know if there are any old aged truths that have already been discovered or are even well known to most regarding this topic. It's possible I am writing about a truth that is well known to all of you investors out there. Maybe what I've seen in the last few years is an abnormality but I do not think so. What I see is a pretty clear pattern in the path of least resistance in the markets. (Actually I'm willing to bet that someone has discussed this topic in great detail, somewhere.) I am not talking about technical resistance or support levels here but using the term in a much more general way, more like friction.

By my observations, every market day has similar traits that I try to take advantage of or avoid as necessary. While I see a pattern, I have to at least come up with a working thesis as to why this might be true or I would think this is just nothing more than watching a short term trend. My thesis is based on a view of the world that comes mainly from a math and physics background. It is a well known fact that many events occurs due at part to the path of least resistance. Electronics and fluid dynamics are just a few of these sciences that reply on this principle.

So how does this path of least resistance affect the market? From the 9:30 am opening bell to the 4 pm closing bell I see this in action almost every day. This also explains much about after market trading.

Before the opening bell, I see pent up demand to buy or sell stocks. The resistance here is that the market in general is not open yet so the resistance builds. Much of this pent up demand is based on news released during the closed markets from the day before as new information is fit into the puzzle. In the physical world, imagine a river that has been dammed up. When the bell sounds, the resistance is cleared and this pent up demand to take action (in either direction) shows in high spikes at the open and very quick reversals. So many people want to establish or remove a stock position that they are literally climbing the backs of others to get their orders in. Imagine a dam blocking a river suddenly bursting open. I wouldn't want to be in that path of that water and in the same way I try to avoid this time in the market. If I do try to get an order in, I make sure it is a limit order. (I learned this lesson in a very expensive way by placing a market order for naked puts on Microsoft in Dec of 1999 after bad news form the night before.) Then I can try to play the quick and sharp reversals usually seen about 5-15 minutes into the trading day but only if I have a strong conviction on what I think will happen.

After the froth of the opening, the market looks for a direction just like the waters of a dam start looking for a way to travel down the path of least resistance. The huge initial resistance is gone (the market is now open) and the waters that just spewed about have started to channel into a direction. This seems to occur daily between about 10:30 to 11:30 am each morning. The news is getting digested. Maybe more news is coming in or maybe it's just lunch time. The effects of the news are being analyzed, log jams are broken and new paths start forming. Frequently this is a short lived peak or bottom and a V shaped reversal. These are times I can consider making some money. If it is a short lived top, I might sell into this or if I think this was a downtrend that will not last, it could be a good time to enter a position.

During the middle of the trading day, the least amount of resistance is evident as stocks start moving in a more consistent direction and there is no longer an urgency to change a position. News and sentiment generally drives this time of the day and there is plenty of time to make a move. Relative to the raging waters once the dam burst, this is generally a relatively smooth path where the channels have been carved out and the logjams broken up (without dramatic news that can alter the course of the water or market.) Trends are becoming evident for the day. If I have conviction in this trend as being a longer term trend, I might consider using this part of the day to change a position but usually I sit this out looking for clues into tomorrow and doing research or looking for news that will turn the course of this river.

The last part of the day again, has much more resistance as it builds up to the close. The 2:30 to 4 trading hours can once again, move the markets quickly as resistance builds up again. The waters have traveled downstream and as now finding all the niches to store water have been filled and uphill gravity becomes a factor and log jams start building up again. The traders, knowing the market will close soon are getting positions ready for the following days or taking profits and cutting losses during this time period and many rallies are broken here as well as many decline reversals are seen during this time period. The closer we get to the resistance of the market close, the more activity we generally see. When I am taking profits, I might wait until close to the 4 o'clock close to maximize my profits where the most resistance is. When I am trying to establish a new position, I am much more likely to try to buy in around 2 before the market resistance starts creeping up and inflating prices.

After hours trading gets a short note here. With very few relative buyers and sellers, the resistance is extremely high and this the spreads between the ask and bid prices can be outrageous. In effect, there is nowhere for the water to slow so it just splashes around a bit. I typically will not tread in this area but if I do, I will have very tight limits on my transactions.

Note that this seems to be true during a rally or decline (excluding important news, which I admit can be frequent and negate this pattern for the day.) The direction is not really important here. It is the resistance patterns and reversals or directions that I am referring to.

In my opinion following the path of least resistance patterns can help you find the right times to get into and out of positions on short term trades or find better pricing on longer term investments.

Happy trading,
Uncle John