Stocks & Commodities V.

25:7 (36-39): Premarket Prediction by Victoria Wang TRADING TECHNIQUES

Powerful Or Picayune?

Premarket Prediction
Can premarket activity be a powerful predictor as to how underlying stocks will perform during regular market hours? Will this knowledge be advantageous to traders?

by Victoria Wang remarket activity refers to stocks that undergo active trading before the US market opens that is, before 9:30 ET. This activity may be caused by earning announcements from either before the market opens or after yesterdays close, upgrading or downgrading by analysts, or other news that may influence the stocks movement. After analyzing about a half-years data, we are beginning to uncover the connections between premarket activity and stock trends during regular trading hours.

DATA COLLECTION
The first step in the analysis is data collection. The premarket data was collected from the NASDAQ website from February 1, 2006, to July 31, 2006. We wrote a program that fetched the data from the website every morning around 9:25 ET. This data includes the current price before the market opens, yesterdays closing price, and the premarket trading volume. Using this data, we were able to calculate the percentage change of the current price relative to yesterdays close, referred to as percent change. We will discuss the effects of these data on the underlying stocks movements during regular trading hours. Trading activity involves entering a position at the open price and exiting the position at the close of the day; therefore, this

is a daytrading system. For short positions, we are limited to stocks with a price above $6.

PRICE RANGE EFFECT

The effect of the price range on the average percentage return for long positions is illustrated in Figure 1. In this

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Stocks & Commodities V. 25:7 (36-39): Premarket Prediction by Victoria Wang

figure, we set premarket volumes to those above 10,000 and the percent change to those greater than or equal to 20%. Gap up stocks with a higher price range that is, prices equal to or above $50 tend to have a positive average percentage return of 4.46%. However, due to the small number of data applicable to this range, these observations may not be statistically reliable. Stocks that range from $10 to $25 and $25 to $50, on the other hand, perform poorly in long positions. The average return for stocks between $10 and $25 is -2.74% with winning odds of 22.2%, while stocks priced between $25 and $50 have an average return of -4.65% with all trades being losses. Based on this observation, it would be advisable to short gap-up stocks priced in this range. For prices between $5 and $10, there is an average return of 0.79%, with winning odds of 41.7%. Stocks priced less than $5, or penny stocks, have more volatile trading patterns. A few have large positive returns, but most of them lose money in long positions. Overall, there is a 2.46% average return with 33.3% winning odds for this price range. For gap-down stocks, long positions turn red across all price ranges. Gap-down stocks less than $5 have an average return of -5.65%, with winning odds of 33.3%. Stocks from $5 to $10 have an average return of -0.71% with winning odds of 27.8%, while stocks priced between $10 and $25 lose 4.65% with winning odds of 22.7%. For stocks between $25 and $50, the average return is -5.03%, with no winning trades. However, there is little data for stocks in this range, so conclusions may not be statistically reliable. Because there is no data available for stocks priced above $50 with a percent change of 20%, we will use a 10% change for this average. In this case, the average return is -2.30% with winning odds of 28.6%. Since all price ranges lose money for gap-down stocks, it would be preferable to take short positions when trading gap-down stocks.

6.0 % Gap up Gap down 4.0 2.0 0 -2.0 -4.0 -6.0 -8.0

Average return (%)

<5

5-10

10-25 Price ($)

25-50

>50

FIGURE 1: EFFECT OF PRICE RANGE ON AVERAGE PERCENTAGE RETURN. Blue bars indicate gap-up stocks in long positions. Maroon bars indicate gap-down stocks in long positions. Premarket volume and percent change are held constant at greater than or equal to 10K and greater than or equal to 20%, respectively, with an exception for gap-down positions above $50, which have volumes greater than or equal to 10k and percent changes greater than or equal to 10%.

4.0 % Gap up Gap down 2.0

Average return (%)

-2.0

-4.0

-6.0 Stocks less than $5 -8.0 Stocks greater than $10

5-20

>20 5-20 Percent change (%)

>20

PREMARKET MOMENTUM EFFECT

Premarket volume and percent change indicate the momentum of a stock. For gap-down stocks, premarket percent change correlates to the average percentage return of the stock, with large percent changes correlating to greater losses in long positions during normal trading hours (Figure 2). For gap-up penny stocks, the average return for all volumes greater than or equal to 10,000 and percent changes between 5% and 20% is in the red at -1.13%. However, if the percent change is increased to 20%, with the same volume of greater than or equal to 10,000, the average

FIGURE 2: EFFECT OF PERCENT CHANGE ON AVERAGE PERCENTAGE RETURN. Blue bars refer to gap-up stocks in long positions, and maroon bars indicate gap-down stocks in long positions. The left side of the graph concerns stocks with prices lower than $5.00. The right side of the graph concerns stocks priced higher than $10. Premarket volume is greater than or equal to 10,000.

The trends visible during the premarket have indicative power on the actions of the underlining stocks during the regular trading hour.

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Stocks & Commodities V. 25:7 (36-39): Premarket Prediction by Victoria Wang

return increases to 2.46%, as shown in Figure 2. Increase the volume even further to a value 12.0 % Gap up Gap down greater than 500,000 while maintaining a percent 10.0 Stocks greater than $10 Stocks less than $5 change of 20% or greater and the average return 8.0 boosts to 9.95%. However, trading penny stocks 6.0 is not for the weak of heart, as the winning odds are 4.0 at the greatest about 33.3%. It is interesting to point 2.0 out that an increase in premarket percent change 0 for gap-up stocks priced above $10 leads to a -2.0 greater loss. For example, stocks in this price range -4.0 with a volume greater than or equal to 10,000 lose -6.0 on average -0.75% when the percent change is -8.0 between 5% and 20%. When this percent change -10.0 increases to a value greater than 20%, the average return drops even further to -3.16%. 10-100 >100 10-100 >100 Changes in premarket volume produce an inVolume (thousands) triguing effect. For gap-down stocks priced below $5, an increase in volume leads to a decrease in the FIGURE 3: EFFECT OF VOLUME ON AVERAGE PERCENTAGE RETURN. The left side of the graph average return, but the opposite case can be seen illustrates the effects on penny stocks, those less than $5.00. The right side shows the effects on for stocks priced above $10 (Figure 3). For ex- stocks greater than $10. Premarket percent change is held constant at all values greater than or ample, the average return for a stock less than $5 equal to 20%. with a percent change greater than or equal to 20% loses -0.79% with a volume in between 10,000 and 100,000. results of the premarket system against a reference point: the Once this volume is increased to a value over 100,000, the percentage change between the daily open and close prices of average return drops to a -6.86%. However, the average the NASDAQ Composite in a short position, which we named return of a stock greater than $10 would increase from - the NASDAQ index. The historical quotes of the NASDAQ 10.24% to -3.31% with an increase in volume under similar Composite were downloaded from the Yahoo! Finance circumstances. website (see Related reading at the end of the article). The effect of premarket volume on gap-up stocks is more By holding a short position for both gap-up and gap-down straightforward: the larger the volume of the stock, the higher stocks, this system has the capability to outperform the its average return. In general, we prefer to trade stocks with NASDAQ index, shown in Figures 4 and 5. large premarket momentums. This large momentum proShorting the gap-down stocks on Monday results in an vides liquidity and tends to be more predictive when trading. average return of 2.28%, with the system beating the NASDAQ index 19 days out of 24. Shorting gap-up stocks is not as productive, with a marginal return of 0.12% and only 10 winning days out of 23. DAY OF THE WEEK EFFECT On Tuesday, shorting gap-down stocks gain 1.51%, with In addition to analyzing trends formed 16 out of 25 days returning a profit. Shorting gap-up stocks by premarket momentum and price, yields a profit of 1.20%, with the same number of winning we also studied the effects of the day days as those of gap-down stocks. of the week on the patterns of average Gap-down stocks yields an average return of 1.32% with return. Our premarket system shorts 15 winning days out of 23 on Wednesday. Gap-up stocks both gap-up and gap-down stocks perform worse, returning 0.21% with 10 winning days out of 23. priced above $6 with a volume of 10,000. We compared the Shorting the NASDAQ index on Wednesdays loses money, with
Average return (%)

Day Mon Tue Wed Thu Fri

Avg. return 0.12% 1.20% 0.21% 1.26% 1.97%

NASDAQ Beat Index Winning Total avg. (days) days days 0.32% 0.27% 0.26% 0.08% 0.18% 12 16 12 19 20 10 16 10 16 19 23 25 23 26 24

Day Mon Tue Wed Thu Fri

Avg. return 2.28% 1.51% 1.32% 2.11% 0.99%

NASDAQ Beat Index Winning Total avg. (days) days days 0.32% 0.27% 0.26% 0.08% 0.18% 19 16 18 17 18 16 16 15 17 15 24 25 23 26 24

FIGURE 4: SHORTING GAP-DOWN STOCKS. NASDAQ refers to the average percentage difference between daily opening and closing prices of the NASDAQ Composite.

FIGURE 5: SHORTING GAP-UP STOCKS. NASDAQ refers to the average percentage difference between the daily opening and closing prices of the NASDAQ Composite.

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Stocks & Commodities V. 25:7 (36-39): Premarket Prediction by Victoria Wang

an average return of -0.26%. This is the only day that shorting the index results in a loss from February 1 to July 31, 2006. Trends on Thursday for gap-down stocks resemble those of Monday, with an average return of 2.11% and 17 winning days out of 26. Gap-up results give an average return of 1.26%, with similar winning days as those of gap-down. Overall, Thursday is a good day to short both gap-up and gapdown stocks. Fridays results are interesting. Shorting gap-down stocks returns an average of 0.99%, while gap-up results outperform gap-down results with an average of 1.97%. Gap-down results are at its poorest among the five days of the week, while gap-up results are at its best. The number of winning days for shorting gap-up stocks also surpasses those of gapdown stocks.

Generally speaking, shorting gap-down stocks is profitable, while holding a long position in penny gap-up stocks with large momentums makes money. Shorting gap-up stocks perform well on Tuesday, Thursday, and Friday, whereas shorting gap-down stocks performs well from Monday to Thursday. The NASDAQ index, in a short position, performs most poorly on Wednesdays. For the most part, shorting gap-up and gap-down stocks returns a profit and outperforms the NASDAQ index. Keep in mind that these conclusions were reached through analysis based on data from a short period of time, during which the market experienced a down cycle. More studies will be presented when more data is available. Victoria Wang, a high school junior living in California, participates in and organizes a variety of school clubs and indulges her love for classical music by playing the piano. She loves math and science and helps her mother in her trading by applying the critical thinking skills she learns from her activities to stock market data analysis.

PREMARKET MOMENTUM
To conclude, the trends visible during the premarket do have some indicative power on the actions of the underlining stocks during the regular trading hour. Certain price ranges tend to perform better than others, and the premarket momentum of a stock is an important predictor as to whether a gapup or gap-down stock will stay up or down, respectively.

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