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How are traders navigating recent Stock Market Volatility?

July 21, 2020 By Mircea Vasiu

Different types of investors exist. Retail traders often buy stocks just to profit from the price increase in the shortest time possible. Often, they buy penny stocks due to the perceived impression that cheaper stocks have a lot of room to go to the upside than more expensive ones.

This belief was also fueled by the impossibility for many traders to actively participate in trading stocks with a higher stock price for the simple reason that they cannot afford it. However, this changed recently as fractional investing/trading increased in popularity.

Another way is to simply buy an index. Either directly buying the index or an ETF (Exchange Traded Fund) that follows an index’s performance, it is a way of gaining exposure to the stock market. But was it the best approach to do so?

Buy the Close, Sell the Open

Various strategies exist when trading an index. The classic one is to buy and hold. By doing that, traders forgo the benefits of receiving and reinvesting a possible dividend. In other words, the opportunity cost is higher, and the index should outperform in such a way to cover for the implicit cost of not receiving dividends.

For this reason, investors tend to buy and hold individual stocks and not necessarily an index. However, different trading strategies have the potential of yielding much better returns. For instance, buying the close and selling the open (basically trading the futures market, or the after-hours market) would have yielded almost 700% in the last three decades. On the contrary, a strategy of buying the open and selling the close on the S&P500 on a similar time horizon would yield a negative 7%. It means that almost all significant rallies took place in the after-hours.

In a way, it is normal. Since many companies report their quarterly earnings after the market closes, the reaction is stronger than usual due to thin liquidity conditions. Hence, the after-hours rallies outpace the regular hours trading activity.

This is just an example of the S&P500, one of the most popular stock market indices, on how a different strategy leads to totally opposite results. It shows, once again, the complexity of trading financial markets and how traders and investors may gain from a slightly different approach than the one popular among most traders.