As a day trader, you constantly dream of being able to predict current trends in the stock market. Is the market going up or down?
If you believe in the former, you usually need to hurry to buy into the major stock indices in the morning, and then lean back and hope to make money for the rest of the day. But how can you know where the market is heading?
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Countless strategies try to predict the day’s trend based on so-called technical analysis, and usually, this includes the use of several advanced technical indicators to assess whether the market is overbought or oversold.
However, there is a simpler method that, with high probability, can assess whether the market will go up or down on any given trading day. The method we call ‘Stable morning trend’ is based on the fact that the stock market generally rises over time. Typically, the major indices rise between 5-10% per year. Some years even more.
This knowledge supports the principle that the stock market generally rises slowly and steadily throughout the day unless there is nervousness and negative undertones in the market. As a day trader, you should therefore assess every morning whether the market is nervous or not. If the market is nervous, you should consider staying out or going short. On the other hand, if the market seems stable and strong from the morning, you can expect that the market likely will rise for the rest of the day. If so, you can consider going long.
How do you assess whether the market is nervous or not?
The rule of thumb in the ‘Stable morning trend’ strategy is that the market is considered nervous and unstable if there are relatively large price fluctuations already in the opening hour. Violent fluctuations occur because all the major players (banks, hedge funds, etc.) have different opinions about the market in the seconds after the stock market opens and immediately start ‘arguing’ about the market direction.
The idea behind this strategy is that you choose a large index (for example, S&P 500, DAX, or FTSE), and then wait an hour after the market opens to assess how nervous or calm the market appears.
For this assessment, a normal candlestick chart on an hourly basis is used. A candlestick always shows the lowest and highest price in the period (in this case 1 hour), and if this first 1-hour candlestick is not very high compared to the last 500 candles going back in time, then you know that the market is calm compared to the last 500 hours.
Ideally, the first candlestick bar after market opening should be SMALLER than the top 10% of bars in the period. In other words: There should be at least 50 candles among the last 500 candles that are HIGHER than the first candle after the market opens.
If that’s the case, you can prepare to go long in the market.
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The actual signal for buying comes in the following candle (the second hour after market opening). If this candle is also relatively low and bullish, then you have confirmed the assumption that the market is calm, and the index will likely rise during the day.
Therefore, you buy into the index and set your stop 1% below the price. You close your trade around the stock market closing time (hopefully with a profit).
The above method has been tested on several different index ETFs – among others by JBmarwood Research. The result was that the method produced more winners than losers, and the losses were often smaller than the gains.
The opening period gives a good indication of the market for the rest of the day. When volatility is high already in the morning, it typically continues for the rest of the day. If the volatility is low in the morning hours, it is often a signal that the market will rise quietly and steadily for the rest of the day,” JBmarwood Research writes.
It may seem overwhelming to assess the height of 500 candlestick bars, but in most cases, you will quickly be able to estimate by eye whether the day’s first candle is high or low compared to the average and especially compared to the top 10%. You should avoid counting candles in the ‘aftermarket’, and therefore it is smart to count candles by looking at an ETF chart that reflects the index you want to trade. If it’s about DAX, you can use the ETF called DAXEX. If you trade the S&P 500, for example, you can use SPDR S&P 500. The trades can then be taken as leveraged investments in a CFD contract, for example, Germany 30 or US500.
Remember that this number is only used to test the strategy. In practice, one can develop one’s own assessment of whether the morning’s first candlestick is volatile or not, and thus use this assessment as a basis for whether the day’s trend goes up or down. If you have trouble counting candles, you can also try a volatility indicator, for example, ATR or ADX. However, this has not been tested.
If you as a day trader want to protect yourself even more against fluctuations, you can also combine the strategy with looking at the major economic indicators, for example at Forex Factory. Important macroeconomic indicators often shake the market, and therefore one should only choose to trade the above strategy if there is no prospect of ‘red’ macroeconomic indicators during the trading day in question.