*This primarily applies to the stock market. The U.S. stock market closes at 4 pm. This doesn’t really apply to the forex, commodities, and futures markets.
Medium and long term traders and investors should use the close price for trading stocks (i.e. enter buy and sell orders near the close of each day’s trading session). This small risk management trick is especially useful during market crashes. Here’s why.
No difference when selling a stock in a rising market
Let’s assume that you are long a stock. You want to sell it in a rising market because the rally is “too overextended”. You want to sell today because the market is extremely overbought on an hourly bar chart. Let’s assume that you want to sell at 1 pm.
We did the historical backtests. There is no difference between selling during the intraday when the market is “overbought” and waiting until the close to sell. An extremely overbought reading on the hourly bar chart doesn’t mean that the market will top right now during the intraday (e.g. at 1 pm). There is a 50-50 chance that the market will go higher towards the day’s close. Overbought can become even more overbought in the short term.
Hence, it does not hurt to wait until the close to sell your position. Sometimes it will be better to sell on the intraday. Sometimes it will be better to sell on the close. But ON BALANCE, it doesn’t make a difference between selling on the intraday and selling on the close when the market is rising.
Difference when buying a stock in a falling market.
Using the close price instead of an intraday price makes a difference when the market is falling. ON BALANCE it is better to buy on the close.
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Let’s assume that the market is falling. You want to buy into the falling market because the selloff is “too oversold”. It’s 1 pm, and the market is also extremely oversold on the intraday hourly bar chart.
It is better to wait until the close before buying the stock.
- Sometimes the market will bottom during the trading day (e.g. 1 pm).
- Sometimes the market will crash all the way until the end of the trading day.
Historically, there’s a >50% chance that the market will close near its daily low when the market is crashing. Buying on the close will help you save a few percentage points when the market is crashing.
The stock market’s biggest historical crashes fell from the open all the way to the close. Anyone who bought on the intraday when the market was “oversold” would have been down a few percent by the close.
Here’s the October 19, 1987 crash.
Traders thought that the Dow Jones was insanely oversold by noon when it was down -200 points. The market ended up crashing another -300 points, bring the total to more than -500. Oversold can become more oversold on the intraday.
The stock market’s tendency to crash until its close is also evident in the August 2011 crash. The market tended to close near its low each day when the market went down.
This tendency was also evident in the August 1998 crash. The stock market closed near its low each day in the final downleg.
This tendency exists in bear markets too. The market tended to close near the low of its daily range when it was crashing in 2008.
This pattern exists for a logical reason. When the market is crashing, algos jump on the bandwagon and push the market down even more. Human traders and investors panic because the market is falling, so they sell even more stocks. The nonstop trading day from 9:30 am to 4 pm means that a lot of these traders and investors don’t have time to calm down and think logically. They sell just because everyone else is selling. The selloff becomes a self-fulfilling prophecy, so the market closes near the lows of the day.
These human traders need the overnight break to calm down and think logically. They panic sell towards the close, but start to trade logically the next day. That’s why the market often crashes towards the close, goes lower in after-hours trading, and then surges the next day.
I use the close for entering and exiting positions in my Medium-Long Term portfolio. I use intraday prices for entering and exiting positions in my Day Trading portfolio, but that’s because the Day Trading Model’s time frame is very short.