When the open is up
If the open is up from the close the day before, you imagine that the first trader of the day spotted overnight news favourable to the security, or is expecting favourable news, or has some other reason to think his purchase will return a gain. If you, too, want to be a buyer today, his action reinforces your feeling. The first trade sets the tone. Sometimes a good opening is due to a practice named buy on open. You can’t automatically attribute optimism or hopefulness to an opening bounce, because
First, mutual fund and other professional managers have pre-set allocations to specific securities. When fresh money comes in the night before, these managers are going to distribute a certain percentage of it to all the securities in the fund selected by the new customer. To buy on open is the easiest way to top up a fund, but this action is not necessarily a judgment on that security that day.
Second, fund managers want to clean out stops from the day before. A stop is a pre-set sell order usually designed to prevent losses or otherwise exit the trade. A stop placed significantly beneath the close from the day before may be hit merely because all the market makers have not refreshed their bids at the time the market opens. This type of buying an open occurs particularly with more lightly traded issues, not the big names trading millions of shares a day. Fund managers and other professionals control far larger sums than individuals do, and you don’t know what proportion of opening trades are due to genuine research-based enthusiasm and what proportion is due to the mechanical buy-on-open effect. The market can take up to an hour to get down to new business. How do you know whether an opening bounce is due to fresh enthusiasm or just the mechanical buy-on-open effect? You have to study each security to see whether it normally displays the effect. Heavily traded, big-name securities (such as IBM stock) are less susceptible to an opening bounce than specialized securities with a narrower trader base (like cocoa futures).
When the open is down
If the opening price is below the close of the day before, look out! Maybe bad news came out after the close last night. The bad news may pertain to a political event, a change in interest rates, a bankruptcy in the same industry, or a zillion other factors. Some traders may have executed a sell on open, although to sell on the open is not a common practice. A sell-on-open order is just what it sounds like — an order given the night before to exit the trade at whatever the price happens to be, although hunting for stops at the open is widespread and can create either a buying or a selling surge (for more on stops, see the section, “When the open is up”).
