Introduction: The Invisible Hand of Overnight Bias in the US Stock Market

When it comes to trading, timing is everything. But did you know that the time of day you choose to enter and exit the market can significantly impact your returns? Welcome to the world of overnight bias, a phenomenon that has far-reaching consequences for traders in the US stock market. In this article, we’ll explore the concept of overnight bias and compare two simple trading strategies to understand how this hidden force can make or break your investments.

Overnight Bias: A Powerful Market Force

Overnight bias refers to the tendency for stocks to experience a disproportionate amount of their gains or losses during trading day and overnight. This can result in surprising shifts in stock prices when the market reopens, impacting traders who buy or sell stocks during regular trading hours. Best demonstration would be to show two simple strategies.

Two Simple Strategies: Buying SPY on OPEN vs. CLOSE

In order to study the impact of overnight bias on trading strategies, let’s consider two simple approaches:

  • Strategy 1: Buying SPY (an ETF that tracks the S&P 500) every market day on OPEN and selling on CLOSE.
  • Strategy 2: Buying SPY on CLOSE and selling on the next day’s OPEN.

While both strategies involve daily trades, they differ in terms of their exposure to overnight bias. Strategy 1 focuses on intraday returns, whereas Strategy 2 is designed to capture overnight returns.

Analyzing Performance: A Tale of Two Strategies

To compare the performance of these strategies, we’ll analyze their equity curves and drawdowns.

Strategy 1: Buying SPY on OPEN, sell on CLOSE

Holding SPY during the day from 1.1.1993 – 31.12.2022

Strategy 2: Buying SPY on CLOSE, sell on next day OPEN

Holding SPY overnight from 1.1.1993 – 31.12.2022

Let’s take a look at the key findings from our analysis:

  • Strategy 1 (OPEN to CLOSE) had a lower profit than Strategy 2 (CLOSE to OPEN), suggesting that the overnight bias had a significant impact on returns.
  • Strategy 1 (OPEN to CLOSE) is not profitable at all!
  • The daily returns for Strategy 1 were more volatile than those for Strategy 2, indicating a higher level of risk.
  • Both strategies experienced periods of outperformance and underperformance, influenced by factors such as market conditions, economic events, and investor sentiment.

Comparing the Strategies: The Impact of Overnight Bias on Performance

Here are the key takeaways from our comparison of the two strategies:

  1. Overnight bias had a notable impact on returns, with Strategy 2 (CLOSE to OPEN) generally outperforming Strategy 1 (OPEN to CLOSE).
  2. Strategy 1 was not profitable at all – it just mean that US Stock made almost all of their profit overnight.

Conclusion: The Overnight Edge: How US Stocks Tend to Rise Overnight

Our analysis not only highlighted the impact of overnight bias on the performance of the two trading strategies, but it also revealed an interesting pattern: US stocks tend to rise overnight. This phenomenon can be attributed to various factors, such as global market developments, economic news released after trading hours, and the anticipation of positive earnings announcements. By recognizing this tendency for stocks to appreciate during non-trading hours, traders can potentially capitalize on the overnight edge to enhance their returns.