This piece was originally posted on August 24th, 2023.
Years ago, when I was managing a hedge fund, I used to check the futures markets every evening and every morning. That’s a way of tracking stock prices during the off hours for regular trading. The futures used to be predictive, or at least when prices moved a lot after the close, was useful as an indicator that there was significant market-moving news.
During the early part of the Covid-lockdowns, the markets were extremely volatile with the futures market often moving mid-single digits overnight. At that time, seeing the futures down 5% – 6% at 3am was a good indicator that the market was going to open with lower prices.
Over the following year, there was a strange trend where overnight losses would evaporate during the day. Short-term traders were able to make money by shorting the indexes at the close, and then buying back the position at the open. Being short the market overnight and long the market during the day was an effective trading strategy at the time. There was also a time when this relationship reversed and it was better to own at night and be short during the day.
While there are traders who earn good returns following these trends, I’ve tended to avoid them because I can’t determine causality. No one really knew why stocks traded this way, and as a result, there was no way to predict when the trend would end and the strategy would become useless. It’s also likely that these trading trends get reinforced by more speculators following it. This is akin to the Theory of Reflexivity that George Soros wrote about years ago. Simply stated, the more people participate in a trend, the more pronounced the trend will be. Eventually, you can end up with too many people doing the same thing at which point the observed system collapses.
The meme stocks like Gamestop GME and AMC Entertainment Holdings AMC are perfect examples of this. These stock prices took off when investors wanted to participate in the momentum trade and crashed when the reflexive weight of too many people doing the same thing no longer supported the insane valuations. The key point is without some sort of valuation aspect to the thesis, these things work until one day they don’t, and you end up with a crash.
Over the last year, I’ve noticed a different trend. Most days, the overnight futures markets aren’t predictive at all. The intra-day volatility tends to take stocks up and down huge amounts, and the explanations tend to be organized later. When the futures markets aren’t predictive, the pundits wait until the end of the day and tell us why stocks went up or down during the day. At times, the answer is obvious such as when the mega-cap tech stocks announce great earnings, or Jerome Powell telegraphs more rate hikes. Other times, the explanations are clearly made up to support a short-term narrative, and the pundit has no idea what really happened.
This morning was a perfect example. After Nvidia NVDA announced a fantastic quarter last nigh, the stock was up almost 10%, and NASDAQ QQQ futures were up almost 1% in the aftermarket. The index opened up close to 1%, and quickly fell. Within 18 minutes of the open, the index was back to flat, and as I write this just before noon, the index it’s down 1.5%. That’s a huge swing of 2.5% in just a few hours. $NVDA is barely up on the day.
DKI’s response to this is to continue to focus on the long-term value of select stocks we know well. If the short-term trading signals are volatile, inconsistent, and non-predictive, then the right response is to ignore short-term volatility and find stocks, themes, and ideas that will do well long-term. I still check the overnight markets multiple times; partly out of habit, and partly to ensure I’m on top of any significant news. However, as these signals have become less predictive, I’m spending a lot less time and mental energy focusing on them.
GB@DeepKnowledgeInvesting.com if you have any questions.
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