- The idea that the overnight market (close to open) doesn’t influence the daytime market (open to close) is usually correct, but NOT when the overnight market is moving violently like it has recently.
- Large gaps down exhibit a relatively strong negative correlation to subsequent daytime changes indicating a tendency to reverse some of the overnight gap in the daytime. I haven’t shown it in these statistics, but the larger the gap down, the higher the average return and the more negative the correlation (but also the higher the volatility) of the daytime reversal.
- Large gaps up do not exhibit a consistent influence in all market conditions. Also not reflected in these statistics is that as the size of the gap up increases, the correlation to the daytime market becomes more and more asymmetrical based on the broader trend. In up trending markets, these very large gaps up exhibit strong follow-through (positive correlation), but in down trending markets, very strong reversal (negative correlation).’
“Bottoms are made when selling becomes exhausted and long-term participants perceive value and lift stocks sharply off their lows. That exhaustion can occur over a period of months, as fewer stocks and sectors make new lows over time and individual stocks and sectors find fresh buying interest. Thus far, we’re not seeing such selling exhaustion; weakness has, so far, begotten further weakness. While it is tempting to call market bottoms and pick up bargains, all we can say Wednesday is that a historically weak market just got weaker.”
“Place your stops at a point that, if reached, will reasonably indicate that the trade is wrong, not at a point determined primarily by the maximum dollar amount you are willing to lose.”
If you are using automated trading systems, the most appropriate approach for stop loss’ defining is applying Average True Range. For example you might use 1.5 times or 2 times 10 days ATR. It will depend on your trading horizon.
If you are proprietary trader (most likely trend follower), it is reasonable to put your stop loss 10-20 cents below major area of support. Again, the area of support would be defined by your investing horizon.