Factor Market Action, Sector and Industry Performance, and Time of Day Into Your Trade Entries

When listening to the pundits describe what happened today in "The Market," it's easy to come away with a misconception that there is such a single entity that can be so easily categorized.  That, unfortunately, is a very dangerous trap, especially for a beginning swing trader.  There are numerous factors that influence a stock price at any given time, and for those of us that are attempting to capitalize on short-term (typically less than a week) swings in prices, understanding those forces is most beneficial to the health of our trading accounts.

The Market

Dow Jones Industrial Average

When the evening news armchair pundits refer to "The Market," quite often they are simply talking about the Dow Jones Industrial Average.  What's misleading about this, however, is that it represents only 30 large-cap stocks, the performance of which result in a price-weighted composite value tracked in just about every daily newspaper in the nation.  At its inception in 1885, it was intended to represent Industrial stocks, however in recent years the stocks that make up the average now span a wide variety of industries including fast food (McDonalds,) consumer electronics (Apple,) or retail (Wal*Mart.)  While widely tracked, it's not the best indicator of market health for the swing trader.  Rather, there are several others that I watch much more closely:

S&P 500 Composite Index

As the name implies, the S&P 500 is a market-weighted index of 500 large-cap stocks that was designed to be a much better gauge of the risk/return characteristics of the large-cap universe as a whole. The movement of this index is typically far more indicative of the health and performance of the large cap stocks than is the Dow Industrial Average.

Nasdaq Composite Index

This index is a great one to watch if the stock you are trading is listed on that exchange.  The characteristics and performance of Nasdaq listed stocks are subtly different from those listed on the NYSE, and when you're engaged in short-term trading, subtle differences are often the edge you're looking for.

S&P 1500 Composite Index

This is an often overlooked Index, but I do follow it.  It includes all of the stocks in the S&P 500, 400, and 600 indices, and it covers 90% of the market capitalization of stocks.  If your stock is not one of the S&P 500, this index will provide a better view of the pressures influencing price than will that specific index.

NYSE Composite Index

For broad market depth, this one's the grand-daddy of them all.  It includes all of the stocks listed on the New York Stock Exchange, and is perhaps the best indicator of overall broad market performance.  If the stock you're trading is listed on the NYSE and is not a large-cap stock, this index will give you a much better feel for market pressures than will any of the other indices listed above.

Sectors and Industries

Stocks are categorized into 9 broad S&P sectors.  (Well, originally 10, but when the S&P created their SPDRs, they combined two of them.)  These sectors are

• Materials (XLB)
• Energy (XLE)
• Financials (XLF)
• Industrials (XLI)
• Technology (XLK)
• Consumer Staples (XLP)
• Utilities (XLU)
• Health Care (XLV)
• Consumer Discretionary (XLY)

Each of those sectors is then sub-divided into industries.  For instance, there are 10 industries in the Materials sector, including such groups as "Paper", "Gold Mining", and "Aluminum."

Knowing which sector and industry to which your stock belongs is essential.  Alcoa, for instance, is in the Aluminum industry within the Materials sector.  This is important information since on a day-to-day basis, the performance of the industry and sector has a far greater impact on the price movement of the stock than does anything going on with the company itself, barring a major news release.  

Time of Day

Believe it or not, the time of day in which you enter a trade can have a significant influence on your prospects.  This is especially true for those of us that work full-time jobs and cannot watch the market unfold, carefully selecting our exact point of entry.  The trading day follows a rather natural rhythm, however, and you can plan for it.

9:30 to 10:00 - The half-hour following market open is extremely volatile and often chaotic.  There's no sense, yet, of the direction the market will take, and it's not uncommon for the market to reverse direction approaching that 10:00 hour before settling into where it wants to trade for the day.  I avoid opening new trades in the first half-hour of trading since it's been my experience that it increases my overall risk of a bad trade.

11:30 - The European market close occurs at 11:30 Eastern Time.  If there are major events going on in Europe, I'll keep an eye on market behavior starting around 11:15.  Quite often it can give you a feel for how the US markets will behave as we approach our own close.  I only avoid trading in this time-frame, though, if it's extremely hectic in Europe based on major news events.

12:00 to 14:00 - Many traders are taking lunch in this time-frame, and trade volumes tend to drop.  Since I'm not trading based on intraday patters, however, I tend to ignore that fact.  A day-trader needs to be aware of it, but since I'm holding positions for 1 to 5 days on average, I don't do anything special here.

15:30 to 16:00 - Volatility will start to increase again in this period as we approach the close.  I tend not to open new positions in this time-frame, both because of that volatility (although most of the volume occurs in the final five minutes) and because, if the trade didn't trigger earlier in the day, then the signal that generated that setup did not have the momentum I want to move it quickly enough and far enough to be profitable.  The longer I go without a fill, the more likely I am to cancel the trade, and my experience is that, for the strategies I trade, a fill this late in the day will likely result in a loss.

Putting it All Together

For the strategies I follow, and indeed for the strategies that comprise successful swing trading in general, we want the most factors moving in our favor as possible.  That means that, if I'm opening a new position, I want the following:

• A strong setup signal with multiple confirming signals on the chart.  (The type setups I look for will be covered in another post.)
• The broader market moving in the direction of our trade.  Which index I'll use for this when setting up the entry order will be one of the indices listed at the start of this post, based on the index in which this stock best fits.
• The sector moving in the direction of our trade.
• The industry moving in the direction of our trade.
• The time of day being between 10:01 AM and 15:29 PM Eastern Time.

The trading platform I use allows me to setup all of those conditions when creating my order ticket, which is ideal since I work a full time job and can't manage the trade in real-time.  Quite often, this combination does not come together in time for an entry at the price specified.  That's fine.  There will always be another opportunity for another trade tomorrow.  Protecting capital is paramount, so there's no reason to enter a trade unless you've lined up as much as possible in your favor.  Give yourself that edge.  You can be certain that the person or computer on the other side of your trade is doing the same.

Happy Trading.