Night Moves for Daytraders

Daytraders tend to avoid the uncertainties of the overnight markets, believing there's too much risk in holding stocks at the end of the day. However, it's possible to use the overnight markets to your advantage. Most profits are, in fact, created between the close of one session and the start of the next.

Price moves away from an entry point as a function of time. This means intraday profits tend to be a lot smaller than longer-term ones.

Microholding periods also frustrate attempts to raise winning percentages because daytraders need to exercise perfect timing over and over again. In contrast, overnight traders can survive tons of whipsaws and still book substantial profits.

Daytraders can control trading losses more efficiently than overnight traders, but this market edge is usually washed away by higher transaction costs.

Of course there are risks when carrying positions overnight. Adverse news can trigger nasty gaps and earning surprises can hurl stocks into unexpected places. This danger is especially high in range-bound markets.

However, you can overcome the majority of these risks with a good trading plan. Above all else, stay informed and don't get blindsided by earnings releases, options expirations or other cycles that decide market direction.

Never hold a position ahead of earnings unless you have a clearly defined edge. You don't know how earnings will move a stock, regardless of your expectations, so stay on the sidelines and let other traders assume the risk.

One classic overnight play has worked poorly since the bubble burst five years ago. New traders are taught to expect follow-through after a stock closes out near its high or low tick. But today's trap-and-fade environment can reverse the strongest trend of the prior session.

Holding stocks over the weekend scares traders, but the strategy is even more profitable than overnight positions taken midweek. For example, I bought Mettler-Toledo (MTD - commentary - Cramer's Take) in the final hour on Nov. 18. The chart below showed a bullish pattern, but the stock just wouldn't break out as the week came to a close.

On Monday morning, it gapped up and ran, right on schedule. Why does this strategy work so well? Consider all the weekend technicians looking for new stocks to buy. Their furious hunt increases the odds that a broad audience will discover the stock and be willing to bid up prices when the new week begins.

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Alan Farley is a professional trader and author of The Master Swing Trader. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback; click here to send him an email. Also, click here to sign up for Farley's premium subscription product The Daily Swing Trade brought to you exclusively by TheStreet.com.

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