“The most liquid period is the opening. Liquidity starts falling off pretty quickly after the opening. The second most liquid time of day is the close. Trading volume typically forms a U-shaped curve throughout the day. There’s a lot of liquidity right at the opening, it then falls off, reaching a nadir at midday, and then it starts to climb back up, reaching a secondary peak on the close. Generally speaking, this pattern holds in almost every market. It’s actually pretty amazing. ”
– Monroe Trout, New Market Wizards
It’s interesting to think about the U-shaped liquidity profile in the context of an old belief: Dumb money trades at the open, while smart money trades at the close.
If the open and the close are the most liquid parts of the day — the open being dominant — it’s probably more accurate to say the bulk of money trades at the open, period.
As for why trades at the close look smarter, there is a simple explanation: Time position. More information is available at the end of the day than the beginning. The opening trades on an FOMC day come before the 2:15 announcement; the closing trades come after it.
There is also a way to interpret EOD (end of day) trades as “smarter” regardless of what happens:
- If the market reverses into the close, EOD trades can be painted contrarian / dodging a bullet.
- If the market stays directional into the close, EOD trades can be painted as confirming the trend.
With that said, there are logical reasons for avoiding the opening in respect to new trade executions… the frequency with which opening prints reverse, for example, is also explainable through the U-shaped liquidity lens. (If most of the buying gets done in the first three minutes, there are greater than normal odds an exhaustion reverse will follow, etc…)
p.s. follow us on Stocktwits & Twitter! @MercenaryJack and @MercenaryMike