The early riser not only receives the worm. It also makes most of the profits from the stock market. This is because the majority of SPX’s gains, + 1.18% from the S&P 500, occur overnight. The US benchmark index barely gains on average while the New York Stock Exchange is open. That’s the finding of a recently updated study titled “24-Hour Market Return: A Puzzle.” Its authors are Oleg Bondarenko from the University of Illinois at Chicago and Dmitriy Muravyev from Michigan State University.
This overall result is based on a 14-year average and, needless to say, the pattern did not hold for each and every trading session. Still, Muravyev told me in an interview, the pattern has been remarkably consistent. An indication of this consistency: Even if you eliminate the 10 of these 14 years in which the pattern was the strongest, the pattern is still statistically significant in the remaining four. Last year he came up with a real-world test for this market pattern, and that’s what the professors looked at in their recently completed update of their original study. Not only did they find that the pattern held in 2020, it was actually much stronger than the 2004-2018 average. Why should this pattern exist overnight? Muravyev said he believes the main cause of this night-against-day pattern can be traced to the stock market’s reaction to the uncertainty. He and his co-author obtained tick-by-tick histories for CBOE Volatility Index VIX, -10.67% (VIX) futures, and found that these and the E-mini S&P futures are inversely correlated. That is, the VIX on average tends to drop significantly starting around 11:30 pm ET, just as S&P 500 futures begin to rise. This inverse relationship between the stock market and the VIX makes theoretical sense, of course. Investors react negatively to increases in uncertainty, just as they tend to react positively when volatility falls. But why should uncertainty drop around 11:30 pm? Muravyev said that is when European investors start trading their portfolios and their collective actions help reduce the uncertainty that has built up since the New York Stock Exchange closed the previous day. Without a doubt, he added, at all hours of the clock there will be some investors who are just waking up, looking at their terminals and adjusting their portfolios. But a critical mass of investors is required to alleviate uncertainty, and Europe appears to be the only non-US region of the world that provides that critical mass. A confirmation of this explanation comes from the S&P 500’s overnight performance ahead of a European holiday. Many European traders will be less focused on the stock market and indeed, on average, the nightly pattern on the S&P 500 does not exist on those days. Investment Implications The most obvious investment implication of this research is that traders buy S&P 500 E-mini futures at 11:30 pm ET and sell them at 3:30 am “Despite trading twice a day. day, “the professors report, this business strategy” remains profitable net of conservative estimates of trading costs: exchange fees, commissions, and the bid-ask spread. Its Sharpe ratio after cost exceeds that of the purchase and retention “. Futures trading is not for amateurs and can be especially risky for those unfamiliar with it. So even if you were tempted by this strategy, a good idea would be to consult with a qualified financial professional first. You should also trade on paper for at least a month or two before risking your money. Finally, know that this nightly pattern manifests itself on average during many trading sessions. So be prepared to follow this trading strategy with consistency and discipline for a long period of time or don’t bother. Given these ratings, you may decide that a good night’s sleep is worth more than the earnings from night trading. Still, this research shows why you shouldn’t be surprised the next time you see the S&P 500 perform much better at night than during the day. Mark Hulbert is a regular contributor to MarketWatch. Your Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at firstname.lastname@example.org More: What the story tells us about the future performance of international stocks More: Stock investors can only hope that the years after COVID 2020 are not like the ‘Roaring 20s’