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Trading Strategy that trades the Night – Night Trading and an Overnight Edge

Last Updated on 20 April, 2023 by Samuelsson

There seems to be an overnight bias — the tendency is for the gains to accrue during the night — in the stock market. So, overnight trading may yield good returns. In fact, since 1993, most of the gains in the S&P 500 have occurred between the close of one trading day and the open of the next trading day. Thus, we can create night trading strategies to take advantage of this bias. Interestingly, this bias is also seen in the gold markets.

In this article, we will explain what overnight trading means and how it works and then show some backtesting results of overnight trading strategies.

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What does night trading mean?

Night trading, also known as overnight trading, means holding positions overnight — from the close of the trading day until the open the next day. For example, the official trading hours for the US stock market are between 09:30 am and 04:00 pm Eastern US time. Night trading, therefore, means holding a position in the US stock market from 1600 until 0930 the next day.

This is a bit different from after-hours trading which refers to buying and selling a stock outside the official trading hours. For overnight trading, you place buy orders at the close or just seconds before the close and then sell at the open of the next day or put in a limit or market order at or very near the opening price.

Why hold positions overnight?

Most of the gains in the S&P 500 over the last 30 years have come overnight

Take a look at this chart, which shows the accumulated returns of owning the S&P 500 from the close to the open next day:

Trading Strategy that trades the Night - Night Trading and an Overnight Edge

The chart shows 100 000 invested in the ETF SPY and compounded from 1993 until May 2021. Obviously, there is a solid edge, and there is a nice tailwind you can take advantage of when building strategies. However, the average gain of 0.04% is tiny and, of course, not enough to make money if we include slippage and commissions.

This bias is not only seen in the equity market; we found the same tendency in gold (GLD):

Trading Strategy that trades the Night - Night Trading and an Overnight Edge

As you can see, you get a tailwind of about 0.04% by owning gold from the close until the next open.

Looking at gold miners (GDX), you notice that the edge is even bigger:

Trading Strategy that trades the Night - Night Trading and an Overnight Edge

From the chart, you can see that 100 000 invested in GDX and compounded from 2007 until May 2021 gives a CAGR of 35%!

Why there is an overnight edge in the markets

The reason is most likely because most companies report earnings after market close, which increases volatility during the overnight period. To put it another way, there is added risk in the overnight hours; so, in the long-term, you should get rewarded for undertaking this risk. And, when the markets open, any macro news, earnings, or whatever news get discounted rapidly.

Is day trading worth it?

If most of the gains happen at night, is day trading still worth it? Well, for the most part, day traders in stocks may not get any benefit from the long-term tailwind from owning stocks.

The chart below shows what happens if you are invested in the S&P 500 only from the market open to the close:

Trading Strategy that trades the Night - Night Trading and an Overnight Edge

The equity curve shows that, from 1993 until May 2021, you have lost money by buying on the open and selling on the close every trading day. In other words, all the gains of owning stocks have come from holding overnight!

The statistics are even worse for the gold miners (GDX). If you had been buying the GDX at the open and selling at the close every day, you’ve had the following returns:

Trading Strategy that trades the Night - Night Trading and an Overnight Edge

The average gain is -0.09%, resulting in a CAGR of -25%. Horrible!

How to exploit the overnight edge

Despite a solid edge we see in overnight trading, you need to create trading strategies to be able to exploit it; if not, slippages and commissions would make it difficult to gain anything from the edge. Unfortunately, it is not as easy as it seems if you want to trade on the “anomaly” compared to just “buy and hold”.

One strategy we know that still works since 2014 when it was published is the 3 down days – and gap up. See the equity curve below for the seven years of out of sample testing results:

Trading Strategy that trades the Night - Night Trading and an Overnight Edge

As you can see, 2015 and 2016 were flat, but the strategy picked up steam again later. And 2020 was a particularly good year with over 6% gains while being invested just a fraction of the time.

Final thoughts

Overnight stock trading strategies might actually be a low-hanging fruit that any aspiring trader can benefit from. While you won’t get rich by holding and trading overnight, you may be able to make some reasonable profits.

Read more similar articles here on The Robust Trader or on Quantified Strategies

More strategies overnight: Night Edge – SPY trading strategy (Overnight trading strategy)

More strategies overnight:: Overnight Star (Solid Edge since 1998) (Nov 2021) – (SPY+ES)

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