Featured Article

Trading the Pre-Market?

BrandonWendell
Brandon Wendell
Instructor, CMT

I recently received the following email and wanted to address it:

“I follow your articles regularly in Lessons from the Pros and find them very informative. Have been using the supply/demand approach in my trading and have been very successful. However one problem I can’t seem to resolve has to do with pre- market trading. I find the zones very well but my limit price for entry at demand is bided up beyond my price at the open because of pre-market trading and very seldom does it retrace back to my pre-determined entry price. I trade only stocks long. I am considering trading pre-mkt. so as to get my price before the open. Any suggestions? Perhaps you could cover this dilemma in a future article. Thanks for your help in advance!”

Tony D.

As a trader and an instructor in the Extended Learning Track, (XLT), I deal with this problem on a regular basis.  In the beginning of the class, I show a splash screen which highlights the supply and demand zones I am watching and even lists four to six trades I am considering for the day.  I usually create this list the night before.

In the morning when I am in the XLT, I review these potential trades with my students.  I must check to see what trading has occurred pre-market and if there is a possibility of entering the trades.  As Tony mentioned, due to price movement before the opening, price may gap well beyond my expected entry zone and not allow me to take the trade for the day.

The initial thought for most traders is much like Tony’s, enter the trade in the pre-market!  I have to caution you about entering trades pre-market.  I have always had a rule for myself that I would allow myself to exit trades pre-market, but never enter new ones.  When trading we must first strive to protect our capital before we can look to grow it.  That means that we must look for high probability opportunities in the market.

The pre-market trading that occurs before 9:30am EST., is full of dangers.  The first is the wide spread.  The market makers are not typically participating in the trading at this time and even if they do, they are not obligated to fill any quotes they post until the opening bell.  They could post misleading quotes to steer prices to levels they want.  With the lack of participation of the professionals, it is not unusual to see spreads 500-1000% wider than in the normal market hours.  This means if you enter a trade pre-market and then wish to exit immediately due to a change in direction, you are increasing your risk immensely.

The gaps are created by an imbalance between buy and sell orders.  When there is good news on the stock or the economy, investors and traders cannot wait to get in and participate.  This stack of buy orders outweighs the sellers and causes market makers and specialists to move price up pre-market to a level where the orders can get filled.  This is usually a supply zone where there is enough selling pressure to fill the buy orders.

If you buy pre-market, often you find yourself losing at the open because that level is one where the sellers are strong.  This is why we often see gaps filling in the first 15 to 45 minutes of the market opening.  The same happens when prices gap down.

My advice is to be patient and flexible.  Do not trade pre-market.  There are other opportunities that have higher probability and better profits.  Do your research and then adapt to the changing market conditions.  There is an old saying for pilots, “It is better to be a pilot on the ground wishing you were in the sky than to be a pilot in the sky wishing you were on the ground.”   I would like to apply this to trading.  It is better to be a trader who missed a trade wishing they were in than to be a trader in a position wishing they were out!

 

Disclaimer
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.