Trading Strategy Against Overnight Positioning

Overnight Positioning

Because Futures markets trade virtually 24/7 whilst their underlining ‘cash market,’ in many cases, still has set trading hours, opportunities become available in understanding the motivation to trade in the overnight (out side cash session) hours and also how positions accumulated during the overnight session react when the much higher volume cash session begins. Of course understating these things is useful but this then needs to be turned into a trading strategy. First lets look at…

Why Trade Futures in the Overnight Session?

The main, logical, reason to trade futures in the overnight session is to hedge a position held in the underlying cash market as correlated markets that are open move against your position. An example would be selling S&P 500 futures to hedge a stock position as European equity markets fall before the NYSE open. But another reason could be to speculate on a continuation move and use the overnight session as a chance to ‘get in early.’ In the image below short term traders buy above the previous day’s high during the overnight session, speculating on a the gap-and-go type move when the underlying cash market opens…

Dax Overnight Positioning

It doesn’t work out.

How Futures Trade Overnight Creates a Trading Opportunity?

As a general rule futures traders in the overnight session are not large participants, the reason this assumption can be made is large participants need a lot of other traders in the market (liquidity) to execute a large position so therefore will wait until the higher volume cash session where other large participants are active employing multiple different strategies. Therefore those active overnight are typical shorter term/speculative traders – if their taken position doesn’t see continuation they a will likely exit with the profit they have achieved from the overnight move.

The Trade Opportunity arises in understanding where they will exit. There are 2 logical points to exit – either on a failure to continue beyond the overnight extreme: this is a failure to improve their maximum overnight profit. Or if the opening price is taken in the direction counter the overnight move: The opening price is the notional starting price they have got, anything worse than that is seen as a loss. Once the overnight positioning begins to turn, a highly advantageous situation is created, where short term traders are exiting whilst larger traders are reacting to the ‘mis-pricing’ overnight and trading in the same direction. As a result, a reasonably straight forward move to fill the gap left by the overnight move can be expected.

The overnight reversal trade is one that I have explained in the past . I continue to use it in our Career Training Course not just a one of the many trading strategies taught during the course but as a way to enable new traders to understand the importance of traders intentions and how positioning in a move can undermine the suggested direction market has. Think about positioning next time you see a gap up in a cash session compared to where the previous one closed.


What do you think?

Written by Richard Bailey

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