Price Discovery and Tactics to Time Trading

There is a persistent upwards overnight drift in equity prices and a more volatile intraday session that returns close to zero. This is observed across individual stocks, indexes, futures on indexes and NYSE and NASDAQ listings. The effect is consistent across days of the week, days of the month, and months of the year.

In this report, we examine the explanations for overnight drift and intraday returns, and ways to take advantage.

Taking Advantage of Pricing Trends

For US cash equity traders operating in live markets, there are several strategies to consider to take advantage of the overnight drift, intraday returns and retail trading at the beginning of the day:

1. An opportunistic block price during the first minutes of the trading day as an option on favorable price moves. This especially the case when seeking liquidity or benchmarked to the prior close.
2. Bringing the block execution price closer to market after an initial period, say 15 minutes.
3. Use volume seeking tactics at attractive prices to enhance the performance of schedule algos.
4. Price points may be absolute, relative or volatility adjusted. Liquidnet recommends using peer groups with a demonstrable intraday relationship to take advantage of mean reversion over the life of an order.*
5. Use dynamic scheduling to avoid leaving trading footprints due to habits and standard practices. Dynamic schedules accelerate and decelerate participation when it is appropriate.
6. Use an algo with access to Single Dealer Platform liquidity.
7. Use rules engines to vary execution strategy during the day based on market conditions. Rules may determine a preferred reaction function, or utilize sell-side microstructure models to seek performance.

For buyers:

8. Set an opportunistic block price at two standard deviations below arrival for the first 15 minutes of the day.
9. Change the limit to a basket-relative dynamic price for the remainder of the day.
10. Consider slower participation in names with demonstrable negative intraday drift. This may be especially relevant in Russell 2000 names.
11. Potentially use larger quantities for opportunistic block trading for buys compared to sells around the close.

For sellers:

12. Set an opportunistic block price at two standard deviations above arrival for the first 15 minutes of the day.
13. Change the limit to a basket-relative dynamic price for the remainder of the day.
14. Consider faster participation in names with demonstrable negative intraday drift.
15. Potentially use larger quantities for opportunistic block trading for sells compared to buys around the open.

A cautionary note is required to remind traders that overnight drift and zero intraday returns are observed in the round. Individual stocks will deviate significantly from this path and some may exhibit entirely different and changing patterns. The principles of price-based opportunistic liquidity-seeking are the most broadly applicable. Traders may prefer to use a ladder strategy, to accelerate participation under conditions that are becoming increasing more favorable, or unfavorable, determined by risk appetite.

Written by Simon Maughan, Head of Trading Alpha

^{* For Q2 2021 across the S&P 500 and Russell 2000 indexes the Liquidnet minimum variance basket described how a stock moved 62.2% of the time, outperforming the sector ETF 57% of the time, and with an explanation of price that was more than twice as predictive. For the S&P 500 alone, the basket describes how a stock moves 89% of the time, outperforming the sector ETF 66% of the time with a superior explanation.}