@138Way I started writing this a few days ago but between trading live, testing new strategies in sim, and other errands it has been a very busy week. Hope this helps:
I’ll give some background before answering the question: There’s many participants with various time horizons who are involved in the market for different reasons (speculating, hedging, spreading, market making, etc.). The 5 main time frame groups are scalpers, day traders, short term (2-10 days), intermediate term, and long term. Who chooses to participate right on the open will vary, but there are typically structural and behavioral clues of the sorts of market participants involved throughout the session (things like excess, range extension, degree of directional conviction, order flow phenomena, etc.). Markets can be said to either be balanced or imbalanced. When they’re balanced (range bound) the market is doing a good job of facilitating two-way trade and the prices are seen as being fair enough for both buyers and sellers to be involved. Generally speaking, the shorter term participants are seen to be most active in this sort of a market and they’ll tend to rotate around prices trading back and forth. In this scenario, it is more likely that the longer term participants are more active at the edges of the day’s range, if at all, buying below value and selling above value with the short term participants essentially acting as middle-men facilitating the trade. Short term participants provide liquidity, while long term participants have much greater directional influence. When the market becomes imbalanced both sides are essentially agreeing the the current prices are no longer fair and so it has to move directionally (trending) to entice the opposite activity where two-sided activity can occur again. 3/22/2021 was a good example of an imbalanced market, it had to keep grinding higher to shut off buying and bring in enough selling activity to overwhelm the demand of the buyers. The sell off in the later part of the day could’ve been due to long participants liquidating before the close, buyers no longer being interested in buying at those prices, sellers becoming more aggressive and responding to prices that they think are far enough above value to be good shorts, etc. The market can also become imbalanced for shorter periods of time, last week’s reaction to non-farm payroll was an example of the market very rapidly pricing in the information. Markets spend most of their time in channels or trading ranges which are more two-sided than strong breakouts, which will typically only take up about 5-10% of the bars on a chart.
Now, to work towards an answer to the question, when the market opens out of balance (out of the prior session’s range and outside of prior value), it forces participants to act. The further away it is from prior session’s activity the more time-frame participants it will tend to bring in. This is why markets that open outside balance can lead to big days since so many participants are repositioning. When the market gaps up or down, it can either continue to find activity in that direction or those prices can be rejected and the market can go in the opposite direction. This is why it’s so important to always be monitoring for continuation since it can be easy to get caught on the wrong side of a big day. Price is always auctioning up and down advertising opportunities and participants choose to structure trades based on this activity and their trading objectives.
It can provide some insights, but like I said above the most important thing is to keep watching what’s currently happening in relation to the overall context. For example, when the market gaps down, any sell side activity that is taking place is termed to be “initiative activity” since those sellers are taking initiative and selling even below prices that were previously seen to be fair. This is more aggressive. Likewise, any buy side activity is termed to be “responsive activity” since those buyers are responding to the lower prices. This is more passive. Say I’m monitoring for continuation to the downside, I’d be looking to see the quality of the price action to the down side: Are there consecutive bear trend bars? Are they aggressively selling the lows or are there pullbacks? Are there prominent tails or is there considerable overlap between bars? What is the relationship between buying and selling pressure? Those sorts of questions are asked. These considerations are made within the instrument itself and are very important for generating trade ideas, deciding whether to trade in the direction of the gap or in the opposite direction, the sort of entry to use, targets, and so on. There isn’t a clear cut answer for how to modify strategies since it is something that is generally decided on a case-by-case basis due to the number of variables involved. These are the sorts of things that I take into account for my decision making though. Get in the habit of asking yourself questions throughout the trading day, that’s a large part of how the skill of discretionary trading is built. One thing that relates to the premarket itself that I do take into account is the overnight high and low since the market typically trades beyond at least one of the two.
Something else that can be somewhat useful, but less so, in my opinion, than the market generated information from the instrument itself, is looking at correlated and inversely correlated markets on a quote board. A simple example: if the market has gapped down and all the major indices are down, are the safety assets like 10 year, 30 year, bund, gold, Yen rising or falling? We’d generally expect indices and safety assets to move opposite to each other. That can provide some insight into the potential flow of capital from certain assets to others. Sometimes the market will be fairly clearly risk on or risk off, but many times it will be pretty mixed. This provides a more macroscopic level of context based on the broader market. I consider the quote board to be a very bird’s eye view of the market as a whole and the majority of my attention is placed on the instrument I’m trading itself.