An Unusual Pattern Found in the Stock Market
Introduction:
Are stocks predictable? This is a question that many individuals have pondered, hoping to unlock the secret of predicting the stock market. While it may be difficult to accurately predict stock prices, there is another aspect of the market that is worth exploring – volatility measures. By understanding volatility, one can effectively price stock options using the Black-Scholes model. However, there is one parameter in this model that cannot be directly observed in the market – the average future volatility of the underlying asset. This leads to the question of whether or not one can predict volatility. In this article, we delve into the concept of overnight vs intraday returns and explore the intriguing pattern of stock market growth during non-trading hours. We also discuss a possible explanation for this pattern, known as the “hold and pump” strategy. While this theory offers some insight, there is still much to be discovered in terms of understanding the fascinating world of the stock market.
Full Article: An Unusual Pattern Found in the Stock Market
Investigating the Predictability of the Stock Market
Predicting the stock market has long been a dream for many investors. However, a recent investigation suggests that stock prices are not predictable. But what about the volatility of stocks? Can we predict that? This article dives into the topic and explores the relationship between stock prices and volatility measures.
The Black-Scholes Model: Predicting Stock Options
According to the Black-Scholes model, one can use volatility to accurately price stock options. The model states that one parameter, the average future volatility of the underlying asset, cannot be directly observed in the market. This raises the question of whether one can predict volatility.
The Unexpected Twist: Overnight vs Intraday Returns
In an unexpected twist, it has been observed that major stock markets only experience growth during non-trading hours. This interesting regularity raises questions about how prices can change when the market is closed. The answer lies in the fact that people still place orders during that time, and these orders are used to determine the opening price.
Research on Day and Night Returns
A research paper titled “Day and Night” by Cliff, Cooper, and Gulen reveals an intriguing finding. The paper decomposes the US equity premium into day (open to close) and night (close to open) returns. The researchers discovered that the US equity premium over the last decade is solely due to overnight returns. Night returns are consistently higher than day returns, while returns during the day are close to zero or sometimes negative. This effect holds true for individual stocks, equity indexes, and futures contracts.
Another study by Marie-Eve Lachance titled “Night Trading: Lower Risk But Higher Returns?” further explores the patterns of overnight and intraday returns. The study reveals that overnight returns tend to exceed their intraday counterparts. The research identifies certain stocks that have positive and statistically significant overnight biases, which result in higher returns when invested in overnight. Interestingly, these stocks tend to average negative returns intraday.
Coverage and Interest in the Topic
The topic of overnight vs intraday returns has attracted attention in recent years. The New York Times covered this phenomenon in an article titled “The Stock Market Works by Day, but It Loves the Night.” The consistent pattern of positive overnight returns and near-zero intraday returns has piqued the curiosity of investors and researchers alike.
Explaining the Returns Pattern: The “Hold and Pump” Strategy
Bruce Knuteson proposes a possible explanation for the returns pattern in his paper “How to Increase Global Wealth Inequality for Fun and Profit.” He introduces a strategy called “hold and pump,” which involves constructing a large, suitably leveraged, market-neutral equity portfolio. The strategy entails expanding the portfolio in the morning and contracting it in the afternoon consistently. This strategy takes advantage of bid-ask spreads and thinner depths near market open to move prices in a favorable direction, resulting in mark-to-market gains.
The Need for Considerable Capital and Lack of Evidence
Moving prices requires a substantial amount of capital. According to Knuteson, institutions with approximately one billion dollars of available capital can implement the “hold and pump” strategy. However, it is important to note that there is no concrete evidence of this strategy being used. The remarkable pattern of intraday and overnight returns is the only indication.
Potential Alternative Explanations
Skeptics argue that high close to open returns may be attributed to the release of fundamental company and macro news before the market opens or after it closes. However, it is worth noting that most firms and events tend to match expectations, resolve uncertainties, and generate positive returns. While this explanation may hold some merit, it does not fully account for the day and night effect observed in the returns pattern.
The Search for an Explanatory Model
Cliff, Cooper, and Gulen conducted further investigations to explore alternative explanations for the returns pattern. They concluded that the release of positive earnings information after the market closes does not explain the day and night effect. Other possible explanations could only explain a small portion of the variation in day and night returns for S&P 500 stocks. As of now, there is no definitive explanation for the observed returns pattern.
In conclusion, the predictability of stock prices may still remain elusive, but the pattern of overnight and intraday returns continues to intrigue researchers and investors. The “hold and pump” strategy offers a possible explanation for this phenomenon, although its implementation and existence are yet to be confirmed. Additional research and exploration are needed to fully comprehend the underlying factors influencing the returns pattern and volatility in the stock market.
Summary: An Unusual Pattern Found in the Stock Market
Are stocks predictable? While stock prices may be difficult to predict, one can use volatility measures to properly price stock options. The Black-Scholes model, which is commonly used for this purpose, requires the average future volatility of the underlying asset. However, the question remains: can one predict this volatility? Interestingly, major stock markets tend to experience growth during non-trading hours, particularly overnight. This phenomenon has been observed in multiple studies and has raised questions about its cause. One theory suggests that large players strategically manipulate stock prices through a trading strategy called “hold and pump.” While this theory lacks concrete evidence, it provides a potential explanation for the pattern of intraday and overnight returns. Further research is needed to fully understand and explain this phenomenon.
Frequently Asked Questions:
Q1: What is machine learning?
A1: Machine learning is a subset of artificial intelligence that allows machines to learn from data without being explicitly programmed. It involves developing algorithms and models that enable computers to analyze and interpret patterns in data and make predictions or decisions based on those patterns.
Q2: How does machine learning work?
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Q3: What are the types of machine learning?
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Q4: What are the applications of machine learning?
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Q5: What are the challenges in machine learning?
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