The Fab Five Market Trading Sessions

Will McBride and Dmitry Pargamanik cofounders of Market Chameleon join IBKR’s Jeff Praissman to discuss the five equity market trading sessions and why they exist.

Contact Information:

https://marketchameleon.com/

support@marketchameleon.com

Corresponding Webinar: https://ibkrcampus.com/webinars/market-trading-sessions/

Summary – IBKR Podcasts Ep. 108

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Jeff Praissman

Hi everyone, welcome to IBKR Podcasts, I’m your host, Jeff Praissman. It’s my pleasure to welcome back the Co-founders of Market Chameleon, Will McBride and Dmitry Pargamanik. Hey, guys, welcome back. How are you?

Dmitry Pargamanik

Hey Jeff, thanks for having us.

Will McBride

Hey Jeff, great to see you again and thanks as always for having us.

Jeff Praissman

Oh absolutely. It’s always great to have you guys in the studio. It was great, we just wrapped up a great webinar with you guys on market trading sessions, which we’re going to discuss further in today’s podcast. For our listeners links to the webinar will be available in the study notes here too, so they can, you know, go check out the webinar after listening to the podcast that they like. Will and Dmitry, we’re going to talk about different market sessions and, you know, for our listeners that may not know there’s actually five different trading sessions: free market, the open cross, the regular, the closing cross and the after-hours. Can you guys run through what each of them are and sort of like a brief explanation of kind of a definition for each one of those five sessions.

Dmitry Pargamanik

During the day, when we look at the total volume. We could slice it and dice it in many different ways, and one of them is to look at the different trading sessions and the trading sessions like you mentioned, there are five different trading sessions. They have different rules in place, they have different matching engines, even different participants who may participate in one session and not the other and we’ll discuss some of those. The trading sessions are the pre-market, the opening cross, which is a single price auction, then we have the regular trading hours. We have the closing cost, which is another single price auction and then we have the after-hours trading. If we look at all the trading sessions, the two busiest ones out of them, of course, the regular trading session, the closing cost, that’s the second biggest liquidity event of the day. And the reason for that is that there are entire strategies based on the posing price. There are instruments like mutual funds that base their net asset values, their units that you could redeem or create, and those are all based on the closing price and that’s a special order type and we see a big liquidity event usually at the end of the day. We have the pre-market trading and that starts prior to 9:30 from 4:00 AM to 9:30 AM. You usually see a pickup in the volume that is correlated with the new cycle. So, once we get into the new cycle, we get press releases for companies. We also get economic events released prior to the open and you’ll start to see a pickup in the volume there.

Jeff Praissman

We’re talking about the equity markets, not the option markets in this podcast.

Dmitry Pargamanik

Yes, exactly right. We’re talking about the equity markets.

Jeff Praissman

So you touched on, you know why there are so many sessions, not just one longer one and you kind of briefly mention maybe the mutual funds, but why would a trader participate in certain sessions and possibly not another one on a regular basis? You know obviously the mutual funds are — you define the fact that they’re basing their closing prices now on that but let’s just say, let’s take them out of the picture. They have a very specific reason for doing it. Are there traders that really only concentrate on one or two of the different type of sessions and what would that reasoning be?

Dmitry Pargamanik

Yes. So, in the pre-market, what we see is that the traders are very active. You don’t have passive trading in the pre-market, so you know you don’t have people who are trying to buy stocks and there are IRAS or pension funds. It’s really the active trader who is reacting usually to some kind of a data point, you know?  Either news or something is going on that they want to trade before the market opens, right? They’re ready to trade, they have their systems in place, they’re approved for pre-market trading. They understand the risks, that it’s less liquid and they want that speed, right? They want to be able to go and react to that news even before the market opens.

Then there are other traders who have strategies in place and they only use the regular trading hours. Sometimes it could be a VWAP order and the VWAP order follows the day’s VWAP. It tries to either do better than the VWAP or replicate the VWAP. So those order types will only occur during the regular trading hours, in the pre-market it’s too liquid you can’t really put that order type in. Also, you have pegged orders that depend on liquid markets and those are happening during regular trading hours. It’s not really reacting to a specific news event, it’s more reacting to some kind of a model, a mean reversion model or correlation model. So, it depends on really what you’re trying to achieve, certain trading sessions you can accomplish some stuff other trading sessions you can’t.

Jeff Praissman

And to kind of touch on something you mentioned with the sort of the premarket and I would assume after-hours too, it seems like news or events, or are a large driver for that volume. I mean, maybe some people, you trade them all the time, but it sounds like whether it’s an earnings event, which would be obviously stock specific or maybe even industry specific and other stocks would be following suit of say like a big mover there or maybe a you know a massive economic event or a political event or even something stock specific like let’s just say you take a drug stock and the FDA approves a drug after hours. All of a sudden that stock when it probably maybe doesn’t normally trade at all outside regular trading hours all of a sudden now people are very interested in it because it’s moved. Something’s been approved and it’s moved 50% or something. So is it safe to say that really a large portion of those pre-market or after-hours is — not all of it obviously, — but a large portion is sort of event driven?

Dmitry Pargamanik

Yes, it’s event driven, news driven because it gives us some insights into that type of trader cohort, right? Because we could remove certain types of traders that are not participating in the pre-market or after-hours. So for example, we know options don’t trade in the pre-market or after-hours, they only trade during regular hours. So, we know that this is not a spillover from an options trade. We know that passive orders they’re being executed during regular trading hours. Pegged orders, VWAP orders, those are not going on in the pre-market or after-hours, so we’re looking at a certain type of trader cohort that’s active, reacting to some specific news event most likely and how are they behaving and what is their participation? And one of the things that we do is just keep track of those average volumes to see if the interest or the participation of traders is increasing or decreasing during those trading sessions and how they might be behaving. So for example, right now we’re looking at the pre-market trading and I could just see in the last 30 days if we compared to the previous 30 days, we see a drop off of 13% of dollar notional value of trades. So there’s on average, $5.2 billion worth of stock traded in the pre-market on an average daily volume, and we compare that to the previous 30 days of 6 billion. So, we do see a drop off of 13%. And then we could slice and dice it a little bit further and we see that most of that is coming from a big decrease in retail participation, which is down 20%. And then you could take those numbers and just start to make inferences of why might that be happening, you know? Is our retail investors beyond inflation, the interest rate impact and you know their savings rates are going down, is that impacting how they are trading in the stock market as well? But we do see a significant drop off in the last 30 days, especially in the retail participation.

Jeff Praissman

So, you can really pull a lot of insight from the from the metrics, it sounds like you not only pull it on a market basis, but also individual stock basis and then also the type of client or customer. Whether it’s retail, whether it’s professional, on their volume, how that’s reacting to as well throughout different time periods.

Dmitry Pargamanik

Right, exactly and then we could track those transactions and just get general insights of what’s going on? Trends, the transactions, if there is a shift in focus and then we could compare those relative values as well to see if there’s a shift from one industry to another and so forth. So that’s how we keep track of those volumes and looking at the different trading sessions provides us some of those valuable insights because when you section them off, you kind of can concentrate on a type of trader cohort and see how they’re behaving.

Jeff Praissman

We’ve sort of broken down between the five different sessions. I really want to now focus on the session, the biggest of the five, the regular trading session. The session that everyone knows. You know within that session do you ever look at different time periods?  So, like instead of, you know it’s obviously 9:30 to 4:00, it’s the largest chunk of trading, but are there volumes throughout different periods of the actual regular trading session that can help provide valuable information?

Dmitry Pargamanik

During the regular trading session, you also see if we take the distribution of the volume, you’ll see that the first hour looks much different than the 2^nd, 3^rd and 4^th and then the last hour looks much different where we see the really big volumes in the first hours, the last hour then during the middle of the day drops off. So, if we separate those, we could also just compare how the first hour looks relative to the first hour of the previous days and with the first hour, what we’ll see is a continuation of a reaction to news. Those people who are not trading in the pre-market hours, once we open up they’re putting in their orders and we see a big volume increase in the first hour and then the last hour we also see a big increase and especially the last two minutes. They look a lot different than any other minutes during the trading day and that’s when we start seeing either unwinding of positions or strategies, or the last two minutes is when you can really rebalance your portfolios. Those last two minutes, the closing costs look a lot different than any other minutes that you picked throughout the day.

Jeff Praissman

We had mentioned earlier that this is — we’re specifically talking about the equity markets but you know  I love options, you guys love options. I got to ask the question and I know the Cboe offers a few products that trade not quite around the clock, but they offer some equity index products that that trade throughout the night, as well as the CME Group. Same thing with a few of their equity index options on futures as well that will offer, you know, nearly 24-hour trading. Do you see at some point the regular, for lack of a better word, equity option market kind of following suit and expanding their hours as well to kind of keep pace with the equity market?

Dmitry Pargamanik

Yeah, and I think that’s what they’re experimenting with, especially now you have the SPX, like you mentioned, starting to trade options outside of regular trading hours. And I think ETFs, now they’ll go past 4:00, they’ll trade a little bit further out. And I do think that the industry wants to move that way but it’s a little bit hard because we have this legacy system in place that to do that you’re going to potentially start breaking things. The way things are settled, the way we use reference prices for opening and closing like we just mentioned, creating and redeeming units and a lot of our rules are in place using those regular trading hours. So they did extend the pre-market and after-hours to see how people would trade outside those hours and you have the ability to trade in the pre-market and after-hours but there are also — you could see limitations if you’re trading in the pre-market or after hours. You don’t have access to the full limit order book you know. So, if you place the limit order on the book and it’s not designated to trade in the after hours, you can’t access those orders either. So, I think that the industry does want to move in that direction, but it may not be an easy switch without breaking things and changing a lot of rules. So, it may be slower than we were hoping for.

Jeff Praissman

So, it’s more than just flipping a switch and saying we want to trade longer. They have to keep in mind everything that’s set up as far as how the markets work prior to just simply saying, hey, we want to trade options till you know 8:00 at night right now, let’s go for it.

Dmitry Pargamanik

Yeah, exactly, I don’t think it would be that easy to do. Not across the board.

Jeff Praissman

This is great, I want to finish up with the last question. I know Interactive Brokers is, you know, we’re offer overnight trading from 8:00 PM to 3:50 AM and I think about 10,000 or so U.S. stocks and ETFs and that’s growing. Do you see the major exchanges following suit and do you think we are heading for 24-hour, seven days a week trading at some point down the road as far as just for the equity markets themselves?

Dmitry Pargamanik

Yeah, I think eventually that makes sense to do that, to expand the hours and the technologies out there. It seems like the electronic systems are already out there that could handle that. I think it’s going to be slow to transition to  it and it’s going to take a lot of thought of well what do you do where certain industries depends on an opening price and closing price? How do you settle trades? A lot of things right now kind of depend on those regular trading hours. And I do think that probably things like the SPX and the VIX will see if there’s a lot of participation. You know, that will help if there’s a lot of interest in those extended hours, that will probably help push other things.

Jeff Praissman

Yeah, if there’s a need, they’ll make sure that they’ll cater to that need. This has been great Will and Dmitry and for our listeners to see more educational material from Market Chameleon, go to ibkr.com, click on education and in the top right IBKR Campus and click on our contributors and look for Market Chameleon.  A reminder for our listeners that our podcast can be found on our website under the Education tab, on Spotify, Apple Music, Amazon Music, PodBean, Google Podcast, and Audible. Thank you for listening until next time, I’m Jeff Praissman with Interactive Brokers.