Why Buying Stocks in the Morning Could Lose You Money
When the average investor buys a stock, there are a few things he's concerned with. Namely, how the company earns money. Or things such as P/E ratio, dividends and volatility.
Yet according to research published in the Wall Street Journal, there's another key variable to consider -- what time of day you're making a trade.
Though many of us don't realize it, early in the morning is the most dangerous time of day to buy and sell stocks. The reason is fairly simple. Buying and selling is often at its most frantic in the opening minutes of trading. This leads to greater volatility.
How is this effect created? The gap between the price sellers are asking (the ask) and what buyers are offering (the bid) is at its largest at market open. Within 30 minutes, this gap begins to narrow. It continues to close as the trading day grows longer.
Investors benefit from smaller gaps. They are less likely to overpay or undersell. Larger gaps, in turn, create elevated costs.
The data behind the difference
According to brokerage firm ITG, the difference between ask and bid prices in the first minute of trading is about 0.84 percent. That gap goes all the way down to 0.08 after 15 minutes. It ends at just 0.03 at the conclusion of trading.
These don't seem like large numbers. Yet they can have a serious financial impact as they add up over time.
The opening minutes of the stock market typically see large volume, as overnight orders are pushed through. According to Credit Suisse, the opening 10 minutes alone accounts for five-percent of all trading volume.
Monday mornings, in particular, can be busy and volatile, as investors react to the weekend's developments.
That added volatility can work against small investors. Consider the morning of Aug. 24. The Dow dropped 1,000 points within the first six minutes of trading, before recouping half of those losses a half hour later.
That's one shining example of the wisdom of sitting on the sidelines for the market's first hour.
Action Plan: When should I buy and sell stocks?
Many people pay little attention to when they choose to buy or sell stocks. Some investors buy or sell after work, after digesting the day's news. Others trade whenever they have time to do so, giving little thought to the process.
Yet data has shown that we're usually better off buying or selling when volatility is lower. Sure, it's possible to profit from volatility in any one transaction. Yet over the long haul, investors are better off seeking to buy or sell after the market's true value is established.
Some ideas to consider:
- Do not buy or sell stocks during the first 30 minutes after the market opens. The bid/ask gap is at its highest point.
- Avoid, if possible, placing orders when the market is closed.
- The middle of the day is often a good time to buy or sell. The market has had time to react to the news of the morning. Any overreaction may have been addressed.
- A 2001 study published in the Journal of Economics and Finance asserts that the highest returns and lowest volatility in the U.S. stock market occurs on Wednesday. The same study showed that Monday offered the worst return of any day of the week.
- The finding that Monday has delivered significantly lower returns has been backed up by several other academic studies.
- This phenomenon has also been seen in international equity markets, the bond market and other areas.
- Consider using this information as a guide when choosing when to buy or sell.
Many of us don't give much thought to when we buy or sell. Yet the numbers show that timing is a significant factor.
Follow the steps above to give yourself an extra advantage when making transactions.