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The significance of the close cannot be under-estimated. The close is perhaps the most liquid moment of the day with a final price in the so-called “value area”, or area where prices tend to consolidate. This is an important price in that it will act as a magnet for prices in the subsequent trading session, and it is a general point of reference for the next day. The close can also be at an extreme when prices are running.
The close can give you can excellent perspective on the market if you learn to scrutinize the price action for clues to future market movement. There is often follow-through on a higher or lower close, suggesting overnight stops are hit. This can create a gap on the next morning’s open that can often be “faded” – or traded against.
The close can also help you gain insight into market sentiment. How the market closes can help you understand whether traders are “discounting” upcoming news, or it can suggest the start of a rally or even an intermediate-term trend.
On many days, you will see a price boost in the final moments of trading as short-covering pushes the market higher. This is especially true if the market has been trading lower and there is a rush to the exits as short-sellers wish to cash in their profits. A market trending higher in the final moments is apt to be bullish since no one wants to go home short. The exception, of course, is the free falling bear market in which no one wants to be long. In that case, you only have sellers at the close sending prices to their lows.
A strong close suggests a higher open in the next trading session. Buyers tend to push the market higher the close when they anticipate bullish events in the coming sessions. They want a head start on the crowd. This can be a good forecasting device.
Here are some good ideas to remember about the close:
The close often occurs at an extreme, making the MOC order a good one if you are on the right side of the market.
Like the open, the close is characterized by excellent liquidity – providing you with a fair price.
Today’s close can be used to determine whether tomorrow is a trending day or non-trending day – depending on early morning price action.
When the day has been without a trend, the close is apt to fall in the middle.
Look for where the market has come from to determine where it will likely close.
The Relationship of Yesterday’s Close to Today’s Open
Here’s another interesting question. What does yesterday’s close have to do with today’s open? Because we are essentially trading a breakout system, the market has to move in a positive direction prior to a buy entry. Moreover, the market obviously has to keep moving in a positive direction in order to generate profits. In general, you want a positive opening for a successful buy trade. Here are the key parameters that we want to study:
The difference between yesterday’s close and todays open.
The result of this difference compared with an average of the last five days.
In general, we want to look at the percentage rise or fall that generates the most profitable trades. If, as we suggest, the market is a better buy on a positive opening, how much is ideal? How much is too much? After all, if the market were to gap up, chances are it would trade down and close the gap even if it were very bullish. Our studies show that when you are buying, the best trades occur when the market opens no more than 7.5% of the 5-day average range lower than the previous close. When selling, you don’t want the market to open more than 18% above the previous close. A much higher open would be bullish. This would be negative for selling trades. The following charts illustrate these tendencies.
Using these interesting filters, we again ran the numbers. On 446 trades, the average profit reached $568 per trade (that’s profit after subtracting all the losing trades). The drawdown, meanwhile, became tiny. Again, the power of using filters such as these cannot be underestimated.
Finally, two rules concerning the relationship of the open to yesterday’s close. First, you may want to buy slight weakness, but certainly not extreme weakness. Remember, this is the paradox. A little weakness is bullish. A lot of weakness and want to sell – even at a much lower price! In other words, you cannot say it is a good buyer lower, but also a good buy a lot lower. It simply isn’t. The buy rule: only buy if the market opens no lower than 7.5% of the 5-day average below yesterday’s close.
The selling rule: Don’t’ sell if the market opens more than 18% of the 5-day average range above the previous day’s close. For the market to then turn around and trade significantly lower – where you would then start selling – requires too much of one market. Remember the concept of the average daily range. If the market trades, let’s say, 65% of the average daily range before you enter, what’s left? Well, 35%. Perhaps. That’s if it trades the full 100% of the average daily range. To expect more simply doesn’t warrant the risk. No matter how good your analysis of the market, there will always be those days when you are simply wrong.
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