The opening price signal is a simple and effective gauge for determining the daily trend of a stock. The opening price signal is the last price minus the opening price. If the net difference between the last price and the opening price is positive by 1/4 point or more, it is a positive opening price signal. If the net difference is negative by 1/4 point or more, it is a negative opening price signal. Trade only in the direction of the opening price signal. The opening price signal formula is:
Opening Price Signal = Last Price - Opening Price
When the opening price signal turns from negative to positive, it is the first indication that the stock's underlying sentiment has changed to the upside. When the opening price signal changes from positive to negative, it is the first indication that the underlying sentiment has switched to the downside.
Trade only on the side of the opening price signal. From a short-term risk perspective, the opening price signal allows you to be on the correct side of the daily trend. If you adhere to this principle and respect what it is telling you, it will prevent you from fighting a trend and bottom or top fishing.
While the net price of a stock shows the market sentiment from yesterday's close to today's opening, the opening price signal displays the immediate market sentiment from today's opening price to the last price. With the opening price signal, you can determine whether the opening price was set by real demand or was due to an artificial markup. The opening price signal will let you know what kind of force is behind the market opening, which creates the opening price.
Market makers watch opening prices carefully. After the market opens, if the last price falls beneath a marked-up opening price, it is a signal to refrain from initiating longs or to possibly go short. If there is an excessive down opening and the last price rises above the opening price, it is a signal to refrain from initiating shorts or to go long. When stocks gap up or down, the opening price is the one gauge that market makers can use to determine whether stocks are going to go higher or lower.
Here is an example of a market maker using the opening price signal to take advantage of an artificial markup:
At 9:28 am the S&P futures were up 15 points, pointing toward a big opening for the Dow Jones Industrial Average and the rest of the market. The retail buy orders were lining up on a market makers' desks with smaller investors eager to buy stocks. The latest positive PPI report was nortinflationary, signaling that the Fed would probably not raise rates any time soon. Retail order flow derives mainly from the nonprofessional trading community and is usually driven by emotional extremes. The majority of the larger sophisticated players do not chase excessive markups in the morning, but instead use them as opportunities to take profits or to sell the markup along with the market makers.
With the positive market sentiment, WCOM was marked up in Instinct to 83, up 2 points from the previous night's close. The market makers with the retail buy orders in WCOM were jockeying for position on the inside 83l/4 bids. With the market locked, many market makers were using Select Net to preference other market makers who were at 83l/4 and let them know that they had to either sell stock or move off the offering.
After the market unlocked, WCOM soon opened up at 833/s, up 23/s. The market and WCOM soon pulled back from the excessive markup on the opening retail orders. After WCOM opened at 833/s, within 15 minutes it sold off to 82:/2. Some market makers used the initial markup as an opportunity to short their retail buy orders at prices ranging from 83 to 83l/i, and earned a quick profit. The immediate clue of an excessive markup in WCOM was a negative opening price signal. Although on the surface the market and WCOM looked like they zvere in a strong uptrend, the opening price signal betrayed a different picture.
In the above example, the short-term trend for WCOM and the market looked as though it was positive, but it was actually in an overbought condition. The negative opening price signal provided the first clue that the short-term trend was negative, not positive.
The strongest trend indication occurs when both the opening price signal and the net price both point in your direction. When both the net price and the opening price signal are positive, trade from the long side. When both the net price and opening price signal are negative, trade from the short side.
A gap-up on the opening above the previous session's close produces a positive net price. If the stock sells off beneath the opening price but remains above the previous session's close, the result is a positive net price with a negative opening price signal. For example, if a stock opens up 2 from the previous session's close, and then pulls back 1/2 point, the opening price signal is -1/2, and the net price is +IV2. In this situation, market makers will use the opening price signal as their first measurement to determine what side of the market they want to be on for the short term.
It pays to wait patiently for both the opening price signal and the net price to point in your direction. When these two signals act in harmony, you have optimal conditions for trading from the correct side of the daily trend. Many times, however, market makers have to make a decision when the circumstances are not perfect, and the net price and opening price signal conflict with one another. When this occurs, the opening price signal serves as the more useful short-term trend indicator, because it evaluates how the stock is trading from today's opening, not just from yesterday's close. It also tends to act as a leading indicator for a change in net price. The opening price signal compares the last price to the current market sentiment, by taking into consideration all the news events that have materialized overnight or early in the morning.
The opening price signal can easily be monitored throughout the day with most software packages. Simply enter in the formula for each stock you are following, which is the last price minus the opening price. Tracking the opening price signal as it turns from positive to negative, or vice versa, provides a profitable entry tactic for timing a change in the underlying trend. The point in time when the opening price signal changes from one side to the other is called the inflection point. Always wait for the opening price signal to point in your direction by at least 1 /4 of a point. The point when the opening price signal changes within 1/4 to 1/2 of a point is the best spot to enter.
Figure 6-3 is a snapshot of a monitor page with symbols and is an example of how a market maker tracks stocks. The monitor page includes the net price, the opening price signal, the bid price, a
To view this image, please refer to the print version of this book
Figure 6-3 Monitor Page Showing Opening Price Signals and Other Indicators short-term moving average, and the amount by which the stock has bounced off its lows or retraced off its highs.
Here is another example of a trader using the opening price signal to position a trade.
EBAY was trading up 4 points at 134 with a positive opening price signal of +2. It had gapped up 2 points on the open from the previous day's close of 130, to open at 132, and had rallied 2 points from there. As the Internet index began to sell off, EBAY's opening price signal went from +2 to -1, with the last price moving from 134 to 131. EBAY was still up 1 point on the day, but was now trading beneath its opening price by 1 point. This change in the opening price signal forecasted a change in momentum. A Wall Street trader named Bin shorted 15,000 shares EBAY, which zvas half of his intended position. He only shorted half of his intended position because EBAY zvas still net positive on the day.
Soon after the opening price signal turned negative, EBAY broke beneath its previous night's close of 130. At this point, Bin shorted another 15,000 shares, bringing his total short position to 30,000 shares. EBAY continued to sell off and ended up closing at 123, doivn 7 points on the day. Bin rode EBAY for the meat of the move and ended up making a tidy profit on the trade.
The change in the direction of the opening price signal was the first clue to sell longs and to be prepared to trade from the short side.
The inflection point is a valuable entry area for an intraday change in net price. When a stock's net price changes from positive to negative or vice versa, the underlying daily sentiment has changed. Use this change as an entry point or as a stop-loss point. A change in the opening price signal will always lead a change in the net price, so it can be used as a leading indicator for a change in the underlying psychology and market tone.
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